Does the Potential to Merge Reduce Competition?

The standard paradigm of anti-trust rules is that anti-competitive mergers increase industry concentration and hence increase market power, implying that anti-competitive mergers harm competition ex-post and hence need to be carefully regulated.  Using a model that captures the firms’ activities prior to the merger, we show that potential mergers increase competition, so mergers can be ex-ante pro-competitive.

We restrict our attention to a model that abstracts from influences on mergers that are widely agreed to promote efficiency, such as economies of scale, and develop a focused model that is driven only by the desire of firms to collude, and potentially to merge, forming a monopoly post-merger.  (We recognize that the collusion incentive and technological efficiencies can coexist and can be difficult to disentangle empirically.)  In our model, firms are forward looking, are aware that they are in a cartel arrangement, but are unable to directly observe the actions of the rival firm so as to directly enforce the cartel, that is, in game-theoretic parlance, to punish the rival for perceived deviations---that is, for producing too much.  The inability to directly observe and punish deviations therefore requires a tacit collusion arrangement.

The tacit collusion arrangement entails punishments consisting of increases in output, thus driving down prices and so harming the deviating firm.  Perhaps surprisingly, the potential to merge weakens those punishments, because it prematurely terminates them under terms that are an improvement over the price war for the firm that is being punished.  Because the potential for punishment is concomitantly reduced, the trepidation about aggressively producing output in contravention of the interests of the cartel arrangement is reduced: there is more competition.

From this dynamic perspective, mergers therefore occur only when collusion has failed.  And because we can show that pre-merger collusion is dynamically stable, long periods of collusion are likely.  Therefore, mergers are rare---pre-merger collusion is the normal state of the firms.  Because we detect collusion empirically primarily in the context of mergers, the stability of pre-merger collusion suggests that merging firms might be just the tip of an iceberg of collusion that might not have been fully recognized.

Furthermore, we note that although the monopoly gains stemming from a merger harm consumers in the standard way, the short-run enhancement of pre-merger competition benefits consumers and those benefits dominate the losses to consumers from the later formation of the post-merger monopoly.  This is because discounted expected losses are small if mergers are rare and hence the pro-competitive effect of potential mergers exceeds those losses if firms spend most of their time in pre-merger competition.  This gives impetus to a merger policy that is therefore a bit counterintuitive: reduce barriers and costs of merging so as to harness the pro-competitive effects of mergers.

Therefore, regulators could promote consumer welfare by facilitating mergers through lowering frictions, such as barriers, costs, and expenses formally or informally placed by merger regulation, such as Merger Guidelines of the Justice Department or the European Commission. 

Notwithstanding that the model does not explicitly include a regulator, it informs a controversial debate concerning regulators’ shift in competitive effects theories away from “coordinated” effects---that is, firms consciously colluding---towards “unilateral” (non-coordinated) effects cases, perhaps because single-firm dominance is easier to prove in practice.  Recent evidence, however, revives arguments that tacit collusion is a bigger concern than previously thought, because of convincing evidence of rising concentration.  Using conventional reasoning, the perceived rise in concentration suggests that regulators should revert back to bringing “coordinated” effects cases to regulate markets, and in particular, to block mergers.  Our results suggest that, even if a coordinated effects approach is appropriate ex post, fewer restrictions on potential mergers, not more, ex ante promote consumer welfare.