Antitrust by chance: a unified theory of horizontal merger doctrine.

• Author: Chin, Andrew

In the three decades since United States v. Von's Grocery Co.,(1) in which the Supreme Court enjoined the merger of two grocery chains comprising a total of 7.5% of the Los Angeles market, antitrust law has continued to lack a unified economic framework to guide and justify the structural analysis of horizontal mergers.(2) The development of the modern system of horizontal merger analysis, focusing on market concentration, has not resolved the incoherence and uncertainty in the underlying economic theory.(3) To the contrary, now that structural analysis of market concentration is a requisite element of "virtually every" horizontal merger case,(4) antitrust jurisprudence appears committed to a program of balancing uncertainties, weighing econometric proxies, and applying decision rules to probabilistic statements of fact: a regime of antitrust by chance.

In particular, the use of static measures in merger analysis has tended to obscure the fact that antitrust enforcement is directed toward the dynamic behavior of markets. The federal antitrust enforcement agencies have attempted to clarify that the analysis embodied in their Horizontal Merger Guidelines(5) reflects "a dynamic, rather than a static, model of economic performance."(6) They have met with only limited success. As Daniel Oliver, former chairman of the Federal Trade Commission, has observed:

[C]ounsel for merging parties--and even their economic

advisers--frequently treat the Guidelines as if they were "a set of rigid

mathematical formulas," and a checklist of points to be covered.... As a

result, doing the arithmetic discussed in the Guidelines, without doing the

thinking they require, inevitably tends to conceal the dynamics of any

market.(7)

The purpose of this Note is to demonstrate that the Horizontal Merger Guidelines do express a rational, coherent enforcement policy, informed by the dynamic behavior of market structure. This Note supplies a dynamic market model that enables the reinterpretation of the Horizontal Merger Guidelines as an internally consistent framework of statistical inference. Within this framework, each piece of evidence can be weighed according to its statistical certainty; one factor does not automatically trump another. Specifically, this Note provides and illustrates a method for interpreting the evidentiary factors that have been most frequently dispositive in recent merger case law: market concentration, ease of entry, and concentration trends.

Horizontal merger analysis in the courts usually begins with the calculation of the concentration within the relevant market before and after the proposed merger. The government may establish a presumption of illegality by showing that the merger would "produce `a firm controlling an undue percentage share of the relevant market, and [would] result[] in a significant increase in the concentration of firms in that market."'(8) Alternatively, the government may demonstrate that the merger would "significantly increase the concentration of an already highly concentrated market."(9) This presumption may be rebutted by "'[n]onstatistical evidence which casts doubt on the persuasive quality of the statistics to predict future anticompetitive consequences,' such as: `ease of entry into the market, the trend of the market either toward or away from concentration, and the continuation of active price competition."'(10)

Since 1982, horizontal merger analysis has relied heavily upon the Herfindahl-Hirschman Index(11) (HHI) of market concentration. The federal antitrust enforcement agencies(12) and attorneys general at the state level(13) have adopted the HHI for its convenience and power--a single statistic that can be cited both to describe the structure of an industry and to shift a court's presumption away from allowing horizontal mergers between sufficiently large firms within that industry.(14) Despite some initial skepticism,(15) the courts have also come to prefer the HHI as a measure of market concentration in reviewing challenges to horizontal mergers.(16)

The use of the HHI statistic as a proxy for anticompetitive market structure has left the Horizontal Merger Guidelines vulnerable to attack.(17) Comparing the HHI with the previously favored four- and eight-firm concentration ratios,(18) critics have questioned the HHI's algebraic properties(19) and econometric explanatory power.(20) Although these measurement errors are significant, they need not invalidate the HHI statistic as evidence of market power at trial; after all, every piece of evidence carries an element of uncertainty. The HHI of a market may be used appropriately within a framework of statistical inference which gives commensurate weight to presumptions and countervailing evidence.(21) The dominant interpretation of the Horizontal Merger Guidelines, however, is that the presumption of market power is fixed upon market concentration thresholds that were either arbitrarily chosen(22) or based on static models of market behavior.(23) Understood in this way, the Horizontal Merger Guidelines fail to quantify standards for rebuttal.(24) This is bad statistics and bad law.

Ultimately, the use of the HHI as a proxy for the competitive structure of a given market entails particular statistical assumptions about the market's dynamic behavior. This Note will supply one possible set of dynamic assumptions(25) that will provide a unifying framework for interpreting the Horizontal Merger Guidelines. Within this framework, the HHI thresholds are meaningful, not arbitrary, and the quantitative standards for rebuttal are well-defined, yet flexible.

Part I of this Note reviews the role of market concentration in the context of federal antitrust enforcement. Part II surveys recent decisions that have used the HHI in analyzing the effects of horizontal mergers. Part III presents the notion of a stochastic market model as a framework for analyzing merger cases. Part IV demonstrates the framework's applicability to the analytical factors indicated in Part II. Part V uses a horizontal merger case, United States v. Country Lake Foods, Inc.,(26) to illustrate the framework's potential contribution to the substantive law. Part VI concludes with a discussion of further consequences of the theory.

1. MARKET CONCENTRATION AND ANTITRUST ENFORCEMENT

   A horizontal merger has one certain effect: At the moment of the merger, it increases the concentration of the market. It is less clear that the merger creates market power, harms consumers, or makes an eventual monopoly more likely. Even so, the passage of the Sherman Act established as public policy the nation's concern with the empirical relationship between horizontal mergers and monopoly market power.(27) Consequently, market concentration has always been cognizable under the antitrust laws as an indicator of market power.

   Section 7 of the Clayton Act (as amended in 1950) prohibits any merger or acquisition where "the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly."(28) The Department of Justice is authorized to prevent violations through equitable proceedings in the federal district courts.(29) The Federal Trade Commission may enforce section 7 through administrative proceedings in the agency and injunctive actions in the courts.(30) Private parties may also seek injunctive relief and treble damages from section 7 violations in the federal courts.(31)

   From the earliest years of section 7 jurisprudence, antitrust policy has been directed toward mergers between sufficiently large firms in highly concentrated markets. Brown Shoe Co. v. United States(32) interpreted section 7 as a barrier against "the rising tide of economic concentration" in American industry that applied even "when the trend to a lessening of competition in a line of commerce was still in its incipiency."(33) Subsequent Supreme Court decisions elaborated a burden-shifting, structural analysis of horizontal mergers. In United States v. Philadelphia National Bank,(34) the Court held that a rule of presumptive illegality applies to a horizontal merger that causes a "significant increase in [market] concentration" and produces a firm with an "undue percentage [market] share."(35) Extending this rule in United States v Aluminum Co.,(36) the Court held that horizontal mergers or acquisitions causing even slight increases in concentration are presumptively illegal in highly concentrated markets.(37) In United States v Von's Grocery Co.,(38) mergers causing slight increases in concentration were also ruled illegal in markets where there is a significant "trend toward concentration."(39)

   Market concentration has retained its central importance as a structural measure of competition.(40) In other respects, however, antitrust enforcement regarding horizontal mergers has evolved substantially in the years since Von's Grocery. First, the Department of Justice and the Federal Trade Commission, in assuming primary responsibility for screening all mergers between large firms for anticompetitive effect, have adopted guidelines establishing market concentration thresholds below which mergers will not be challenged.(41) Second, merger analysis now includes a broad range of market factors, including ease of entry, that may be relevant to a finding of anticompetitive effect.

   The Hart-Scott-Rodino Antitrust Improvements Act of 1976(42) requires that the parties to a merger between sufficiently large firms(43) file "Pre-Merger Notification" forms with the Federal Trade Commission and the Department of Justice. Recognizing their limited resources, these agencies adopted a simplified two-stage approach to merger review that was formalized in the agency guidelines. The first stage identified markets in which concentration was initially high and would increase significantly after a proposed merger. The second stage determined whether firms could actually behave collusively in those...