Do the Merger Guidelines Need Revision?
The merger guidelines should be revised, not only to provide clearer guidance, but because the current version makes it harder for the agencies to win cases when they do challenge a merger. The reason is that the guidelines often don’t fit actual agency practice or modern economic theory. For example, part of the reason the DOJ lost the Oracle/Peoplesoft merger case was that its guidelines on unilateral effects do not match modern practice or theory. Such a mismatch makes it harder to convince judges that merger enforcement satisfies traditional rule of law concerns about providing advance notice of legal standards that are clear enough to guide private conduct and meaningfully constrain legal discretion. Here are the areas on which I would focus.
Unilateral Effects. The unilateral effects portion of the merger guidelines should be rewritten because the economics on unilateral effects have no connection to the HHI or 35% market share thresholds used in the guidelines. For example, given that unilateral price effects were established in Staples, it really shouldn’t have mattered whether the court concluded Staples and Office Depot operated in an office superstore market or were simply close to each other in a differentiated office supply market. Their market share was only 5.5% under the latter market definition, but market labels don’t alter the price effects, and why should a merger that significantly increases consumer prices be tolerated just because we can define a large market?
Market Definition. The guidelines thus should not suggest that market definition is required in unilateral effects cases, but should instead provide an alternative methodology for proving such effects. The guidelines could rely directly on diversion ratios, as suggested by Professors Farrell and Shapiro in their prior academic roles. Or, to use an alternative that would look more familiar to courts used to market definitions, the agencies could posit a product space around the merging parties and directly measure the relevant demand elasticities from that space to other spaces, and the supply elasticities within and into that space, and predict price effects directly.
Indeed, this approach seems better than market definition even in oligopoly effect cases because market definitions rest on all or nothing assessments that distort the economic analysis. For example, market definition equates substitutes that could constrain prices increases of 6% with having no substitute at all, and equates substitutes that could constrain price increases of 4% with having a complete substitute, when neither is really accurate. In practice, courts and agencies adjust the weight given to HHI or market share calculations based on judgments about the extent to which buyers could switch to outside the market and the extent to which rivals could enter or expand. But those judgments are simply subjective assessments about demand and supply elasticities that would be better to make openly, and once we make them we don’t really need market definition to predict price effects.
Oligopoly Effects. The guidelines now provide a lot of guidance on when a market is likely to engage in oligopolistic coordination, but little guidance on when a merger is likely to worsen coordination, other than for mergers that involve the acquisition of a maverick. Thus, the guidelines lend themselves to Catch-22 effect. If the guidelines indicate coordination is unlikely, then courts conclude the merger cannot produce oligopoly effects. But if the guidelines indicate coordination is likely, then courts sensibly ask why coordination isn’t equally likely before the merger, in which case the merger won’t worsen anything. The guidelines need to be clearer about defining the incremental increase in coordination caused by mergers.
Partial ownership. Although the agencies sometimes challenge acquisitions of partial stock ownership, we don’t have any clear guidelines about when partial ownership will count as sufficiently active to be assessed as a merger. Further, some enforcement actions have made noises about challenging partial stock acquisitions on the theory that they might lessen firm incentives to compete with each other. This later theory could apply even when the investment is entirely passive, but so far has not been, and we don’t have any guidelines clearly indicating whether this theory would ever be applied in a case where the investment is entirely passive or what the criteria would be for distinguishing how much passive ownership is too much. Without such advance guidelines, it is hard to imagine winning an enforcement case based on such a theory.