Assessing the efficacy of structural merger remedies: choosing between theories of harm? Steve Davies and Matt Olczak, ACLE EC Competition Enforcement Data Workshop, Amsterdam, April 2008

Motivation Motta et al (2002) important trade-off inherent in structural merger remedies: 1)Ensure create a viable competitor to prevent the merged entity establishing a dominant position. However; 2)Creating a viable competitor may enhance symmetry and make collective dominance more likely. Previous literature on the efficacy of merger remedies has focused on 1). In particular ex-post evaluations conducted by CA’s e.g. FTC (1999) and EC (2005). EC (2005) find that the effectiveness of a remedy is more likely to be in doubt the less of the overlap created by the merger is divested.

Our approach Motta (2004) ideally a merger should be cleared subject to remedies ONLY if neither single dominance (SD) or collective dominance (CD) are expected to result post remedy. Our approach: -Assemble a database of structural remedied mergers and identify the structures resulting from the remedies. -Assess the ‘competitiveness’ of the outcome resulting from the remedy.

Remedy sample Davies et al (2008) identified a sample of 62 mergers from 1990-mid 2004 in which the EC seriously considered CD. 25/62 mergers involved a intervention in 1 or more market (4 mergers prohibited). These 25 mergers covered 222 markets where interventions occurred in 118 (30 CD and 88 SD) Of these 118 we can identify the pre merger and post structural remedy market structure in 66 (23 CD and 43 SD). We examine the impact of the structural remedies in these 66 markets (17 mergers)

The scale of divested assets Relative to ME2 ProhibitionRemedyTotal Less99 Equal More44 TOTAL303666

Return to the status quo FINDING 1: the ‘typical’ divestment remedy returns the market share of the merged entity to the pre- merger share of the larger of the merging parties. Who purchases the divested assets? Typically an entrant (In only one merger was the purchaser already present in the market concerned). FINDING 2: the most common outcome following a structural remedy is return to the pre merger market structure. How ‘competitive’ is the pre merger market structure?

Structural Model estimated using POST merger market shares SUM=S1+S2 & RATIO=S2/S1 N=222 markets: ** indicates significance at 99% level Pseudo R2 = %AllSDCDNI Correct Predictions:

Graphical implications of estimated structural model SD CD NI

Assessing competitiveness of market structures ‘Competitiveness’PREPOSTREM NI SD CD1116 FINDING 3: Almost 40% of markets present pre-merger structures which would have been identified by the Commission as displaying dominance (23% SD and 16% CD) – had they been the result of a merger.

Type 1 errors FINDING 4: in 47% (=31/66) of cases in this sample, divestment remedies have resulted in market structures which the EC would have sought to remedy had they been the result of a merger, rather than a remedy. (We refer to these as type 1 errors). Possible interpretations of type 1 errors: 1)EC applies inconsistent criteria between assessing a merger and designing a remedy. 2)‘Sympathetic’ possibility: when framing a remedy constrained by pre merger status quo. If status quo is characterised by CD or SD so too will be any structure attainable by a remedy.

Decomposing Type 1 errors REM: FreqNIDOM PRE=NI, POST=Dom Scope for successful remedy PRE=Dom, POST=Dom Remedy likely to be ineffective PRE=NI, POST=NI No need for remedy Total

Remedy error rates Remedies are fairly ‘successful’ if the market was ‘competitive’ pre merger (error rate 4/23=17%) Remedies achieve almost no success if the market was already ‘uncompetitive’ pre merger (error rate 25/26=96% In 17 cases the remedies were unnecessary & in 2 of these 17 actually counterproductive (error rate 2/17 =12%) Overall support for the ‘sympathetic’ interpretation. The pre merger outcome can constrain the effectiveness of the remedy.

Collective v Single Dominance 25 cases where dominance PRE & POST and remedy ineffective: 19 PRE & POST presented same type of dominance (14 SD & 5 CD) Remaining 6: PREPOSTREM CDSDCD5 SDCDSD1 WEAK FINDING 5: EC appears more disposed to CD over SD.

A second type of error Type 2 errors: refraining from imposing a remedy even though the merger led to a market structure which, in other mergers, it would have associated with dominance. Can type 2 errors be explained by the ineffectiveness of a potential structural remedy? It turns out that often Type 2 errors can be explained by an additional issue not reflected in original structural model – RANK of the merged entity: SD only tool for intervention for non-coordinated behaviour and SD necessarily implied merged entity number 1 post merger. Re-estimate structural model dividing sample: Merged-entity number 1 MN logit: SD,CD,NI Merged-entity number 2 binary probit: CD,NI

Revised predicted theories of harm NI (#2) NI (#1) SD (#1) CD (#1) CD (#2)

Alternative depiction (with S1 and S2 on axes) SD (#1) NI (#2) CD (#1) CD (#2) NI (#1) NI (#2) CD (#1) NI (#2)

Type 2 errors Rank of merged entity Full sample Davies et al (2008) structural model Revised structural model TotalSDCDTotalSDCD # #

Reluctance to find CD when merged entity is not the market leader FINDING 7: for a given post merger market structure, the EC is less likely to remedy on grounds of CD if, post merger, the merged entity would be the number 2 firm. EXAMPLE: consider a post merger market structure with S1=40% & S2=30%. The EC is predicted to find: -CD if the merged entity is number 1 -NI if the merged entity is number 2

Explanations for Finding 7 When the merged entity is number 2, a structural remedy: - Can reduce symmetry (a thus CD concerns) -Cannot reduce the size of the market leader Any remedy moves the market structure closer to a position of SD If, (as in weak-finding 5) SD is viewed as more of a concern than CD this explains a reluctance to find CD in such markets Addition Econometric results show EC significantly less likely to find CD when preS1≥40 & merged entity number 2 post merger.

New ECMR Second, complementary explanation for finding 7: When the merged entity is number 1 a SD finding is at least a possibility. Might this in fact increase confidence in a CD intervention? Particularly relevant since May 2004 when the new ECMR gave the EC a new tool – EC can intervene for non-coordinated behaviour when the merged entity is NOT number 1 Updating the sample: May 2004 – mid additional mergers (274 mkts) identified meeting criteria used to estimate Davies et al (2008) structural model – in particular CE/CD considered a serious issue

Decisions under the new ECMR predicted using structural model Prediction Decision NISDCD NI UE/SD10771 CE/CD200

Evaluating decisions made under the new ECMR UE/SD decisions: -Only 3 where the merged entity NOT the number 1 firm -Typically in markets where under the old Merger Regulation SD would be predicted CE/CD decisions: -CE finding very rare – 2 cases (both ME number 1) -Even here where CE found to be a problem it was coupled with a UE finding in the same market Maverick firms: -Very rare pre the reform of the ECMR -Important in both CE findings under new ECMR (& for UE as well as CE)

Conclusions Assessment of the ‘competitiveness’ of the outcomes arising from structural merger remedies: -Type 1 errors – EC intervention results in an uncompetitive market structure -Pre merger status quo imposes a significant constraint -Weak evidence EC more disposed to CD than SD In markets where the merged entity is number 2: -Explanation for Type 2 errors – EC refrains from intervening in uncompetitive markets -Imposing a remedy for CD leaves an outsider closer to a singly dominant position Evidence from decisions under the new ECMR: -Continued reluctance to intervene when merged entity number 2 -CE findings very rare and coupled together with UE