Evaluations of merger policy usually ask whether the correct decision was made in actual merger cases. Yet by only considering the direct effects of merger policy, these studies may simply be detecting the ‘tip of the iceberg’ with regard to policy implications. Active merger enforcement can also deter firms from engaging in merger behaviour and/or from engaging in certain types of mergers – the ‘what lies beneath’ element of merger policy. Moreover, deterrence effects may be even more important than the direct effects of actual merger investigations.
Does merger policy deter?
Competition-policy authorities generally acknowledge the existence of a deterrence effect for merger policy but have found it difficult to quantify its importance. For instance, the influential U.S. Federal Trade Commission (1999) divestiture study observed that the total effect of the Commission's merger enforcement is presumably much greater than that reflected by the actual number of mergers modified and blocked. Furthermore, the 2001 Congressional submission by the U.S. Department of Justice stated that ‘we have not attempted to value the deterrence effects (...) of our successful enforcement efforts. While we believe that these effects in most matters are very large, we are unable to approach measuring them’. Competition-policy practitioners assume the relevance of deterrence for merger control but little literature quantifies the existence and size of merger policy deterrence effects.
In light of the dearth of empirical literature, a few competition authorities have recently commissioned practical studies to help assess the importance of merger policy deterrence effects. The Davies and Majumdar (2002) study for the U.K. Office of Fair Trading (OFT) attempted to quantify the overall benefit to consumers of competition policy and, in doing so, consider how merger policy deterrence effects might manifest. Moreover, two recent survey-based commissioned studies – one for the OFT and the other for the Dutch NMa – have yielded some evidence that merger policy yields a deterrence effect.
The Deloitte and Touch (2007) study for the OFT involved a survey of legal professionals, and found that for every merger blocked (‘prohibition’) or modified (‘remedy’) by U.K. competition authorities, some five mergers are later either abandoned or altered.1 This five to one ratio should be considered a lower bound, as the survey only captured those mergers abandoned or modified following external legal advice: the decision to alter or abandon a merger in response to a change in the tenor of merger policy is, of course, often taken by firms without legal advice. Accordingly, the U.K. evidence suggests that the deterrence effect exceeds the direct effect of merger enforcement: i.e., every merger enforcement action ultimately affects five potential mergers.
The Twynstra Gudde (2005) study surveying competition lawyers – commissioned by the NMa in the Netherlands – estimates that the existence of Dutch merger policy leads to merger proposals being abandoned 7.5 times per year and altered 15 times per year; thus, 22.5 mergers per year are ultimately affected. As the Dutch competition authority averaged only three merger enforcement actions (prohibitions and remedies) per year over the 1998-2003 period, it appears that each Dutch merger enforcement action ultimately affected 7.5 potential mergers.
An empirical approach
Motivated by the scarcity of empirical literature and a clear policy need for better evidence, we are currently engaged in a research project to quantify the importance of deterrence effects for merger policy. Our CEPR working paper (Seldeslachts, Clougherty & Barros, 2007) represents the first step in this larger research project. There we consider (using data on 28 competition jurisdictions over the 1992-2005 period) the impact of the use of merger policy tools on the proclivity of firms to engage in future merger activities. Unlike the practical studies surveyed above, we consider whether remedies and prohibitions have different effects.
We find that the use of prohibitions by competition authorities does indeed yield a significant deterrence effect in the sense that firms are induced to propose fewer mergers in the following year. In the typical jurisdiction, an additional prohibition would lead to thirty-four fewer merger notifications in the following year. However, we do not find remedies to involve a significant deterrence effect.
While this suggests a more substantial deterrence effect than that found in the two commissioned surveys, it should be noted that our study differs in some important respects. First, we only consider the impact of merger enforcements on the proclivity of firms to engage in future merger activity, while the survey studies consider the proclivity of firms to both abandon and alter future merger activity. This suggests that our results indicate a more robust deterrence effect than the surveys (in line with their claims to be estimating a lower bound). Second, we allow for different merger enforcement tools to have different deterrence effects, while the survey studies lump prohibitions and remedies together. Hence, our results indicate that the overall deterrence effect found in the survey-based studies may be masking some heterogeneity in the effectiveness of different merger policy instruments. This, on the other hand, suggests that our results tend more toward those of the commissioned studies.
While the empirical support for a prohibition-driven deterrence effect conforms to the priors of competition-policy practitioners, the lack of a deterrence effect for remedies comes as a bit of a surprise. Remedies – like prohibitions – should represent a cost to engaging in merger activity; though clearly, remedies likely involve less of a penalty than do prohibitions, thereby implying a relatively smaller deterrence effect. Accordingly, an increased probability of incurring remedies (where some merger related profits are eliminated) should result in fewer merger frequencies.
It may be that prospective merging firms do not perceive the possibility of incurring a remedy to be a sufficient burden to deterring them from proposing a merger. If so, then one must re-evaluate the usefulness of remedies, particularly in light of the recent proclivity by competition authorities to employ remedies instead of prohibitions to deal with anti-competitive problems.2 Remedies may be a more precise tool in the sense that they specifically address anti-competitive elements, but, given the importance of deterrence as a benefit of merger policy, they may be a less powerful tool than currently perceived.
Strengthening the hand of competition authorities
Accordingly, one of the early implications of our research is that competition-policy authorities may want to reconsider their increasing use of remedies as a substitute for prohibitions, since prohibitions appear to have a unique ability to deter future merger notifications. The soundness of this prescription depends, of course, on the assumption that anti-competitive – not pro-competitive – mergers are deterred by merger enforcements. The Deloitte and Touche (2007) study for the OFT provides some corroborating evidence, as their survey of both legal-professionals and managers indicates that the U.K. merger policy never – or rarely – deters pro-competitive mergers. Of course, further investigation of the types of mergers that are deterred, the next step in our research programme, is needed to judge the ultimate value of merger policy’s deterrence effects.
Davies, S. and Majumdar, A. (2007) ‘The development of targets for consumer savings arising from competition policy’, OFT Report No. 386.
Deloitte & Touche. (2007) ‘The deterrent effect of competition enforcement by the OFT’, OFT Report No. 962.
Seldeslachts, J., Clougherty, J.A and Barros, P. P. (2007) ‘Remedy for Now but Prohibit for Tomorrow: The Deterrence Effects of Merger Policy Tools,’ CEPR Discussion Paper 6437.
Twynstra Gudde (2005) ‘Research into the anticipation of merger control’, report submitted to NMa, October 27 2005.
U.S. Federal Trade Commission. (1999) ‘A Study of the Commission’s Divestiture Process’.
1 Firms proposing a merger may be allowed to proceed if they take measures that alleviate the anti-competitive concerns raised by antitrust authorities. Such measures are referred to as remedies. A frequently occurring remedy is the obligatory sale of some subsidiaries.
2 For instance, the European Commission has largely relied on remedies by only blocking a couple of mergers since 2001.