THE DICHOTOMOUS TREATMENT OF EFFICIENCIES IN HORIZONTAL MERGERS: TOO MUCH? TOO LITTLE? GETTING IT RIGHT?

• Date: 01 June 2020
• Author: Rose, Nancy L.

INTRODUCTION 1942 I. THE RISE OF EFFICIENCY ANALYSIS AND INCREASED THRESHOLDS FOR MARKET CONCENTRATION: THE IMPLICIT STANDARD EFFICIENCY CREDIT 1946 A. 1968-1978: Early Merger Guidelines, Williamson & Bork 1949 B. 1982-2010: Greater Recognition of Efficiencies and Higher Thresholds for Market Concentration 1953 II. EFFICIENCIES AND ECONOMICS 1957 A. What Constitutes an Efficiency? 1957 B. What is the Economic Evidence on Efficiencies? 1961 III. THE MANY: MERGERS THAT DON'T GET A SECOND LOOK 1967 IV. THE FEW: INVESTIGATIONS AND LITIGATION 1973 A. "Out-of-Market" Efficiencies 1976 B. Asymmetry of Burdens 1980 CONCLUSION 1081 APPENDIX 1983 INTRODUCTION

The 2010 Horizontal Merger Guidelines (1) (2010 HMG) establish the current basis by which the Federal Trade Commission and the Antitrust Division of the Department of Justice evaluate horizontal mergers, which are mergers of competitors or acquisitions of one competitor by another. (2) Although they are not binding on courts, the Guidelines have been relied upon by courts reviewing horizontal mergers. (3)

The Guidelines establish a taxonomy for analysis that has become familiar to antitrust economists and attorneys, for example, defining product and geographic markets, calculating market shares, considering unilateral and coordinated effects, and then, importantly, looking to outcomes that could defeat any possible anticompetitive effects, very notably the existence of efficiencies. (4)

Here is a stylized example of the role that efficiencies might play in an antitrust review. Imagine two paper manufacturers, each with a single factory that produces several kinds of paper, and suppose their marginal costs decline with longer production runs of a single type of paper. They wish to merge, which by definition eliminates a competitor. They justify the merger on the ground that after they combine their operations, they will increase the specialization in each plant, enabling longer runs and lower marginal costs, and thus incentivizing them to lower prices to their customers and expand output. If the cost reduction were sufficiently large, such efficiencies could offset the merger's otherwise expected tendency to increase prices. (5)

Under the 2010 HMG, the agencies will not challenge a merger if the cognizable efficiencies--that is, "merger-specific efficiencies that have been verified and do not arise from anticompetitive reductions in output or service"--are sufficient to ensure the merger "is not likely to be anticompetitive in any relevant market." (6) Thus, when the concern is that the merged company would unilaterally raise prices, efficiencies must be sufficient to offset all upward pricing pressure from the loss of a competitor. (7) The focus is on outcomes that improve competition, for example, a reduction in the resources needed to produce a given output, lowering per-unit costs. (8)

In this Article, we concentrate on two separate phases of antitrust enforcement. The first, and less studied, concerns the process by which the federal antitrust agencies decide whether to launch a full-blown investigation of a proposed merger: a so-called "Second Request." (9) Only a small fraction of proposed mergers receive such attention, but the agencies challenge a substantial portion of horizontal mergers that are fully investigated and have a high success rate when challenging horizontal mergers in court. (10) The dichotomy in outcomes between the bulk of mergers that receive relatively quick approval and those few that are subject to a full-blown investigation is stark.

We examine two questions: First, are the federal antitrust agencies under-investigating mergers? We believe the likely answer to this question is "yes." The federal antitrust agencies appear to rely on an approach that gives too much implicit weight to the existence of efficiencies in their decisions whether to investigate mergers even though the agencies do not conduct an individualized analysis of efficiencies for the vast majority of mergers that do not result in a full-fledged investigation, because they lack the detailed information at that stage in the process to do so. We describe below the existence of what we call a "standard efficiency credit," which is to say a generalized belief in the existence of at least modest and ubiquitous efficiencies, which we argue below is likely overstated but has the effect of justifying market-concentration thresholds that are therefore likely to be too lax. (11) Second, are the burdens placed on parties to demonstrate assertions of efficiencies too high? We believe that the answer to this question is "no," and critics are not justified in asserting that the federal antitrust agencies and reviewing courts demand too much of merging parties when the existence of claimed efficiencies are reviewed in an individual transaction.

Our answers to these questions are informed by our analysis of the economic literature, which concludes that a substantial body of work casts doubt on the presumptive existence, magnitude, and importance of efficiencies in horizontal mergers. (12) That challenges the revisionist Chicago School approach, exemplified by Robert Bork, (13) which holds that horizontal mergers inevitably produce merger-specific efficiencies. Acceptance of the Chicago School assertion of ubiquitous efficiencies by antitrust practitioners and enforcement agencies has been a change with significant long-lasting effects.

This Article is organized as follows. Part I provides an overview of the treatment of efficiencies in horizontal merger policy, both in terms of historical development and current practice. Part II discusses what should properly be considered an efficiency--a designation that we believe includes true resource savings but not the use of newly-acquired market power--and draws conclusions from the economic literature on the existence and magnitude of such efficiencies. Part III considers the factors that go into deciding whether to launch a full-fledged investigation, (14) and concludes that belief in the generalized existence of efficiencies has led to the application of market concentration standards that are likely too lax and that should be reviewed. Part IV reviews criticisms of the federal antitrust agencies' treatment of efficiencies when investigating or challenging a merger in court and finds that, given current economic understandings, they are not well-founded.

1. THE RISE OF EFFICIENCY ANALYSIS AND INCREASED THRESHOLDS FOR MARKET CONCENTRATION: THE IMPLICIT STANDARD EFFICIENCY CREDIT

   Since the issuance of the first merger guidelines in 1968, the antitrust agencies have changed their approaches to (i) the existence and treatment of efficiencies and (ii) the use of market concentration analysis to identify mergers that may be presumed to be likely to harm competition. The co-evolution of these has reinforced a tendency toward leniency: over time, the accommodation of efficiencies has expanded and market concentration thresholds identifying problematic mergers have risen. One can conceive of these as linked through the implicit use of what we call a standard efficiency credit; a generalized assumption that horizontal mergers typically generate a level of efficiencies that could offset modest increases in market power. While this credit is neither explicit nor applied directly in individual cases, its implied presence has likely contributed to the increase in the level of market concentration measures that are deemed to trigger the so-called structural presumption. (15) Such market-concentration measures define the circumstances in which, based on the impact of a merger on market concentration alone, the government can establish a prima facie case of anticompetitive harm without the need for additional evidence (which is to say they establish the structural presumption). (16) Thus, if the working assumption about the ubiquity and magnitude of efficiencies is wrong, the agencies may be applying their presumption of harm too narrowly.

   In this Part, we review the evolution of the antitrust agencies' approach as expressed through the merger guidelines. Beginning in 1968, the Antitrust Division of the Department of Justice itself offered instruction on the manner in which it would analyze horizontal mergers; in 1992, and since, the Horizontal Merger Guidelines have been issued jointly by the Federal Trade Commission and the Antitrust Division. (17) Over time, the treatment of efficiencies became more generous, the economic perspective favoring their acceptance became widely-accepted, and the level of market concentration that signals presumptive harm increased, as summarized in Table 1 and described below.

   1. 1968-1978: Early Merger Guidelines, Williamson & Bork

      The first Merger Guidelines were issued by the Department of Justice in 1968 (1968 MG). (27) They are notable in three respects. First, they take a very dim view of an efficiencies defense, consistent with the prevailing view of the courts at the time: "Unless there are exceptional circumstances, the Department will not accept as a justification for an acquisition normally subject to challenge under its horizontal merger standards the claim that the merger will produce economies." (28)

      Second, they established the forerunner of the current structural presumption, reflecting the Supreme Court's decision five years earlier in United States v. Philadelphia National Bank, in which it used a measure of market concentration to construct a presumption of harm. (29) Using the four-firm market concentration measure that was standard before the introduction of the Hirschman-Herfindahl Index (HHI) analysis, (30) the guidelines explained that "[i]n a market in which the shares of the four largest firms amount to 75% or more, the Department will ordinarily challenge mergers" that would include, for example, the combination of a firm with 4% market share acquiring another firm with a market share...