THE EVOLUTION OF U.S. MERGER LAW
Debra A. Valentine
Assistant Director for International Antitrust
Federal Trade Commission
August 13, 1996
THE EVOLUTION OF U.S. MERGER LAW (1)
Let me begin by acknowledging that US antitrust law does not embody some ultimate truth. Neither our Congress nor our antitrust enforcers have been to the mountain top and returned with stone tablets engraved with the ten commandments of competition policy. Although some may pretend otherwise, antitrust is neither a science nor a religion. At its best, antitrust is a pragmatic tool designed to achieve important social and economic goals. In US merger policy, those goals have not always been constant, or consistent with each other, and our enforcement tools have not always been perfectly adapted to their tasks. But there have been enduring themes. And the evolution that I will outline has been in the right direction, to the point that today we believe that US merger policy and its enforcement tools produce a result that is in the best interests of the US and US consumers.
It is fair to say that the concerns that led to the passage of US merger laws, and the goals that the laws aim to achieve, are not unique to the United States. All countries that have adopted merger statutes will recognize them: putting limits on large concentrations of economic power, protecting small businesses, preserving competition, protecting jobs, encouraging economic efficiency, and protecting consumers against anticompetitive price increases. The explosion of new merger laws in recent years suggests that the issues may be close to universal. While the solutions adopted around the world have not been perfectly congruent, that underscores my earlier point -- there are no ultimate truths. Balancing priorities and goals, and determining how best to deploy available resources are government decisions that almost necessarily will lead to different results depending on the economic, social and legal circumstances and traditions of an individual country. It is true that the United States started down this path earlier than most and I believe that we have learned from our mistakes over the last 100 years. So, let me turn to a brief history of our merger law.
The Original Clayton Act. The end of the Civil War in the United States brought prosperity as well as peace. The economy boomed and commerce became for the first time national in scope. State laws that had limited the activities of corporations were loosened and large companies began to flourish. "Robber barons" created great fortunes and then increased them by creating trusts -- large combinations of companies that dominated entire industries. Railroads, oil, steel and tobacco were among the sectors that came to be controlled in this fashion.
So great was the power of these combinations that a popular outcry led Congress to pass our first antitrust statute in 1890. The Sherman Act codified the long-standing common law prohibition on contracts and conspiracies in restraint of trade but did not expressly deal with mergers. Although the Act was somewhat successful in eliminating trusts and holding companies as vehicles for cooperation among companies, the Supreme Court did not extend its reach to mergers unless it could be shown that their very purpose was to restrain trade. Not surprisingly, businesses and barons adapted their techniques and the US saw its first great merger wave in the 1890's, after and perhaps because of the Sherman Act.
Congress reacted. In 1914 it both created the Federal Trade Commission and passed the Clayton Act. The Clayton Act prohibited a number of specific business practices thought to be inimical to our economy, including anticompetitive acquisitions. The merger provision, Section 7, prohibited the acquisition of the "stock or other share capital of another corporation . . . where the effect of such acquisition may be to substantially lessen competition between the corporation whose stock is so acquired and the corporation making the acquisition . . . ." By using the words "may be to substantially lessen competition," Congress indicated that it wanted to stop even potentially anticompetitive transactions. If there were competing interests, Congress came down on the side of intervention. It did not require proof that an acquisition definitely would lessen competition substantially, but only a reasonable probability that it would.
What goals did Congress seek to serve by enacting this new statute? The legislative history is complex and often contradictory, but there is no doubt that Congress was concerned about the monopoly power of the great industrial trusts -- it wanted to protect consumers and smaller firms from unfair use of that power. The power of the trusts over labor was another major concern. Because of their economic strength, the trusts enjoyed a substantial degree of protection from strikes. Indeed, an unintended consequence of the Sherman Act was its use by federal courts to enjoin strikes and limit the ability of workers to organize. Congress addressed this in the Clayton Act, by declaring that labor organizations are not conspiracies in restraint of trade, and making clear that workers could act jointly in bargaining with employers without fear of prosecution under the antitrust laws.
There was also a political dimension. The big trusts were viewed as seeking not only industrial domination, but "political supremacy." Competition, on the other hand, was viewed as "the best environment for the advancement and the welfare of mankind," for individual initiative, independence, and responsibility. At the same time, legislators also recognized the need to protect efficient combinations. As stated by one Senator: "The chief purpose of antitrust legislation is. . . . to protect the public from extortion practiced by the trust, but at the same time not to take away from the trust any advantages of cheapness or better service which honest, intelligent cooperation may bring."
That is not the end of the story, however. The original Clayton Act left a number of gaps in its coverage. It prohibited only the acquisition of the stock of a direct competitor. It did not apply, either expressly or by judicial construction, to the acquisition of assets or to vertical or conglomerate mergers. This is because the primary concern at the time was the development of holding companies and the secret acquisition of competitors through the purchase of all or parts of a competitor's stock. But it was soon recognized that the effect of an asset acquisition could be the same as that of a stock acquisition. The Federal Trade Commission repeatedly urged that the loophole be plugged. However, the country soon was preoccupied with other events: World War I; the Depression; the New Deal recovery; and then World War II. But following the second world war, a new merger movement caught the attention of legislators. Congress enacted the Celler-Kefauver amendments in 1950, making the Clayton Act applicable to asset acquisitions and to acquisitions involving firms other than direct competitors.
The 1950 Amendments. A dominant theme driving the 1950 amendments was a fear of what was considered to be a rising tide of economic concentration in the American economy. In 1909, the 200 largest non-banking corporations owned about one-third of all corporate assets; in 1928 they owned 48%; in the early thirties they owned 54%; by 1940 they held 55%. Aggregate concentration increased even further during the second world war, in large part due to the federal government's war production efforts. Some viewed the concentration trend as a threat to the entire economic, social and political fabric of the nation -- to the very existence of free enterprise and political democracy.
Some were interested in retaining local control over industry and protecting small businesses in order to disperse both economic and political power. An interesting feature of the merger movement of the 1940s was that many mergers involved large corporations swallowing up small firms. This contrasted with the era of the business trusts at the turn of the century, when mergers occurred between large companies. This also explains the focus on small businesses during much of the 1950s legislative debate.
At the same time, it was recognized that some mergers could stimulate competition, and that a merger of two small companies might enable them to compete more effectively with larger firms. Some argued that the law should accommodate the owners of small businesses who wished to sell their business. Others saw lost opportunities for entrepreneurs. But there was no effort made to resolve the tension between the goals of maximizing competition as the best way to ensure high quality at low price and protecting smaller, sometimes less efficient firms, from acquisition.
In sum, the Clayton Act presents something of a mixed bag of values and goals. As in other areas of law, the federal courts had the task of deciding how the Act was meant to be applied. Given the mixed and not always consistent purposes that underlie the statute, it is not surprising that judicial interpretations have evolved over time.
The Supreme Court and Merger Enforcement in the '60s
The cases of the '60s reflect a merger law in search of a consistent theory. We see mergers of two small players in markets with many competitors condemned almost as readily as mergers of very large players in very concentrated markets. As one Supreme Court Justice said: "The sole consistency that I can find is that in litigation under [the Clayton Act] the Government always wins." It may not have been quite as simple as that. One could argue that the Court was being faithful to the Congressional desire that trends toward market concentration should be nipped in the bud. One could also argue that these cases reflect a judicial philosophy that favored government intervention to prevent increases in concentration. But these are not rules of law that help us to distinguish "bad" mergers from good ones -- they lead to the result that most mergers are bad. That outcome is not consistent with economic theory or the way markets actually work, and it is not good for consumers.
In 1962, the Supreme Court decided the Brown Shoe case. That case involved the third and eighth largest shoe retailers, whose merged retail shoe chain would have had 5% of retail shoe sales in over one hundred communities. Even though there had been prior mergers in the industry, the market was still, in the Court's words, "fragmented." In many cities there were a large number of competitors. Viewed with today's eyes, the merger did not appear likely to create market power -- that is, the ability of a firm to raise price above competitive levels. But the Supreme Court ruled that the removal of even a relatively small competitor from the market presented a significant threat to competition. By blocking an acquisition in a unconcentrated market in order to protect small businessmen, the Court chose to ignore the possibility that a somewhat larger shoe store chain would be more efficient and result in lower prices for consumers.
In 1963, the Court decided another landmark case, Philadelphia National Bank. This time the merging parties were the second and third largest commercial banks in the Philadelphia area. Their combined share of a highly concentrated market would have exceeded 30% and concentration among the leading firms would have increased by 33%. This was precisely the kind of acquisition that Congress sought to prevent by amending the Clayton Act. The Supreme Court also established some important rules of law in that case. One of them is that there should be a strong but rebuttable presumption of illegality for mergers that produce a firm with an "undue" percentage share of the market and result in a significant increase in concentration. In other words, mergers in concentrated markets are so likely to create market power and put consumers at risk of anticompetitive prices that they are presumptively unlawful. The Court based this presumption in part on the economic theory that " ' [c]ompetition is likely to be greatest when there are many sellers, none of which has any significant market share.' " We thus see in Philadelphia National Bank the seeds of an economics-based examination.
Then in 1966 came Von's Grocery, another well-known (some would say notorious) case. Von's Grocery reverted to a Brown Shoe kind of analysis, relying perhaps even more heavily on a simple numerical count of competitors and the beginnings of a trend toward concentration. The Supreme Court held unlawful a merger of two grocery store chains holding a combined share of 7.5% of the grocery market in Los Angeles, where the four leading firms accounted for 24.4% of sales, and the top eight firms accounted for 40.9%. The total number of grocery stores in Los Angeles was in the thousands. The market share and concentration figures did not approach those in Philadelphia National Bank. Yet the Court did not engage in an analysis of likely competitive effect, other than noting the trend toward concentration -- single-store groceries in Los Angeles had declined from 5,365 in 1950 to 3,818 in 1961.
How can we explain these different approaches? It is possible that the Court was simply uncertain about the merger standards of the amended Clayton Act. Or, given that there were different goals articulated in the legislative history, the Court may have applied in each case the merger goal that it thought best fit the facts of that case. Or these cases may reflect a judicial philosophy that favored government intervention to prevent increases in concentration, and the Court used whatever goal or standard it found in the Act or its legislative history to get that result.
This "pick and choose" approach, despite its flexibility, is not necessarily in the best interest of consumers. Both the Brown Shoe and Von's Grocery cases illustrate the potential pitfalls of focusing solely on one goal or interest, without fully considering the alternatives. In Brown Shoe, the Court recognized a tension between the goals of protecting consumers and protecting small businesses, but seemed willing to sacrifice lower consumer prices in favor of protecting small firms. Von's Grocery likely involved a similar trade-off. Chain grocery stores tend to have some lower per-unit costs than independent grocery stores, and that benefit likely would be passed on to consumers so long as the market remains competitive. Does a supermarket chain with only 7% of sales in Los Angeles have the ability to soak consumers with higher prices when entry into the retail grocery business is easy and rapid? Today, virtually all in the antitrust field doubt that competition was seriously threatened. If that is correct, a consequence of Von's is that small businesses were protected at the expense of consumers.
The merger law of the 1960s has been described as "by far the most stringent . . . in the world." It was a law that, in the words of Robert Bork, was "at war with itself," pursuing congressional purposes -- protection of small business, hostility to small increases in concentration, and lower prices to consumers -- that were not mutually consistent.
Changing Directions in the '70s
The Supreme Court changed course in the mid 1970s. The focus on preserving competitors, maintaining fragmented markets and pursuing other social goals shifted to a critical economics-based examination of market power and how it might be exercised. The change was announced in the Supreme Court's 1974 decision in United States v. General Dynamics Corp.. The case involved the merger of two firms engaged in the production and sale of coal. The Court held that General Dynamics' share of the market after the acquisition, while within the range that had resulted in condemning other mergers, was not an accurate indication of the company's competitive position. This was because a substantial portion of its coal reserves were already committed under contract for future sales, and it was unlikely to obtain additional reserves. The company's depleted reserve position limited its ability to compete for long-term contracts in a market "where the price of coal is set by long-term contracts." Thus, the company could not manipulate coal prices in the future or exercise market power because it would not control enough of the unsold coal entering the market.
The Court also began to rethink how to analyze other antitrust issues. Antitrust law in non-merger areas began to focus heavily on the market effect of business conduct, either in terms of anticompetitive effect such as output reduction and price increases, or procompetitive effect such as greater efficiencies. These developments were widely associated with the so-called "Chicago School" economic ideology. A basic premise of the Chicago School approach is that the sole goal of antitrust is (or at least should be) the maximization of "consumer welfare" or what we today call total welfare. It does not necessarily mean that a particular transaction will lower prices to consumers. Rather, it refers to increasing the aggregate wealth of the nation or, in economic terms, maximizing allocative efficiency. Thus, if a merger promises to result in a more efficient use of resources, it should be allowed even if it also produces market power and increases prices. The Chicago School denies that this approach is anti-consumer. On the contrary, its basic premise is that by maximizing allocative efficiency, all consumers ultimately will benefit.
Another development in the late 1970s was a national mood change that placed growing emphasis on productivity. This development was influenced by growing inflation, lower productivity, an increasingly negative balance of payments, and increasing concerns about our ability to keep pace with aggressive foreign competition. The last point -- foreign competition -- is worthy of particular attention. It is a factor that was not present during the periods leading to the 1914 and 1950 merger legislation. The economy then was much more insular and the competitive significance of imports and the establishment of foreign-owned manufacturing operations in the U.S. were not issues in the earlier legislative debates. But by the late '70s, the competitive dynamic in the market had changed. Foreign competition was here.
Thus, for several reasons, the stage was set for a dramatic change in antitrust. There was a growing recognition among many antitrust scholars, practitioners and the enforcement agencies that the '60s approach -- the focus on almost any increase in market share -- was not always beneficial for consumers. The agencies turned to a new model. The central goal of merger policy, as reflected in new guidelines announced in 1982, was not simply to prevent undue concentration, but to prevent mergers that may create or enhance market power or facilitate its exercise. As I noted, market power is the ability to raise prices above competitive levels, or to maintain output below competitive levels, either jointly by colluding, or by a single firm. Market power can be exercised by affecting price, output, quality or service directly, or more indirectly through tactics such as excluding or disadvantaging competitors. Consumers are harmed because, by definition, they lack sufficient suitable alternative suppliers when firms have market power.
The theory underlying the merger guidelines policy of the '80s -- and today -- is that high market concentration can facilitate collusive behavior, and it can sometimes result in single-firm market power. Collusion can occur in several different ways. The most familiar is garden variety price fixing, where competitors expressly agree on the price they will charge. In addition, a highly concentrated market can also facilitate a more sophisticated and subtle kind of collusion that is difficult to detect -- what we call "tacit collusion" or "coordinated interaction." What it means is that in some situations firms don't have to collude explicitly in order to reach some sort of understanding that each will be better off if they don't compete aggressively against each other. Another insight of the 1980s guidelines was that while market concentration affects the likelihood that one firm or a group of firms could exercise market power, there are other factors -- such as entry -- that may indicate that a merger will not create or enhance market power.
In one sense, this economic theory of the cause and effects of market power was not new. It was recognized during the congressional hearings on the 1950 amendments to the Clayton Act, and it was recognized by the Supreme Court in Philadelphia National Bank. What was new was the view that concern with market power over price would be the principal focus of Clayton Act merger enforcement.
Although the new guidelines perhaps did not go as far as some Chicago School followers might have wished, the guidelines did benefit from the Chicagoans' questioning of the conventional wisdom. The thrust of the policy changes reflected in the 1982 and 1984 revised merger guidelines was generally well received, even by some who criticized the government's actual enforcement efforts. The problem, the critics claimed, was that the government in the 1980's did not actually apply the new merger guidelines. Relatively few enforcement actions were brought, leading some commenters to charge that the government had effectively abandoned its own guidelines. One study reported that the federal enforcement rate fell by more than two-thirds, to challenging only 0.7% of proposed mergers during the 1982-1986 period, from having acted to prevent 2.5% in the 1979-80 period.
Looking back, the actual enforcement policy that was applied in those days may have effectively changed the standard for challenging mergers. Instead of using the standard mandated by the Clayton Act, which prohibits mergers that "may tend substantially to lessen competition," the Reagan Administration's policy seemed to apply a presumption that mergers would not decrease competition except in extreme cases.
A defender of the Chicago School approach (an antitrust official during the Reagan Administration) stated at the time that the Chicagoans were not really concerned about whether markets worked perfectly. The real question was whether, "given a problem in the market, government intervention will result in a net benefit, a net improvement, or whether it's just as likely as not to make things worse." In other words, generally trust the competitive process to work unless you are almost certain that antitrust will make things better.
So we came out of the mid '80s with more analytical rigor, a focus on one version of "consumer welfare" as the bottom line concern of antitrust, and some insightful merger guidelines that government enforcers largely disregarded in favor of a presumption that government intervention was more likely to make things worse than to make them better.
Merger Enforcement Policy in the '90s
Merger enforcement experienced an upturn beginning in the late '80s. More horizontal mergers were challenged, and the Commission renewed enforcement efforts on vertical and potential competition theories. What accounts for this change of events? A continuing merger wave is one answer. There was a sharp upswing in mergers in 1987 and continuing through 1990, and another one beginning in 1993 and continuing today. With more transactions, one expects to find more that are problematic.
Interestingly, the change is not due to a dramatic policy reversal. The Commission and the Department of Justice jointly issued new horizontal merger guidelines in 1992, but the fundamental policy stated in the 1984 guidelines did not change. The policy still is to prevent mergers that may create or enhance market power or facilitate its exercise. At most, we have become more sophisticated at recognizing certain characteristics -- such as product homogeneity, secrecy of the terms of transactions, and sales that are frequent and relatively small -- that may make the joint exercise of market power after a merger more likely.
What has changed is our enforcement philosophy. While the merger guidelines we apply are basically the same, we ironically have more faith that they can be intelligently applied than did our predecessors who authored them. We no longer assume that government will necessarily get it wrong and can only do harm; rather, we apply the available tools in an even-handed way to advance consumer interests, and thus further the various goals that Congress established.
Our goal today is to protect consumer welfare, but we use that term in a different sense than the Chicago School did. It is not appropriate to maintain that the merger laws are only concerned with achieving the best allocation of resources. That is not a fair reading of the legislative history. Merger efficiencies do matter, but so do price increases that consumers have to pay, reductions in quality of products, less service, less variety of goods and services and reductions in other forms of rivalry such as innovation and R & D. We can agree that many transactions are intended to achieve efficiencies, but we won't assume efficiencies in any particular case -- we have to examine what the evidence tells us.
Does protecting the competitive process serve the varied goals underlying the Clayton Act? I think so. If we prevent mergers that threaten market dominance, enhance the likelihood of collusion or erect barriers to entry, and if we allow weak, inefficient firms to merge so that they can be stronger competitors, we preserve economic opportunity, the free enterprise system has the maximum opportunity to flourish, and small businesses have a fair opportunity to compete. While competitors are not protected for the sake of numbers, or for the sake of smallness, the protection of diversity in the market is conducive to "political democracy." Competition also serves the interest in efficiency. The inefficient will be spurred on to be more efficient, for otherwise they will not survive, and firms seeking a competitive edge will be motivated to innovate and be more efficient than their competitors. In sum, our focus on the competitive process serves each of the Clayton Act interests well, even if not equally or perfectly.
So far we have considered the substantive aspects of US merger analysis but I think it important to spend a few minutes on procedural matters. The Hart-Scott-Rodino Act, a crucial amendment to the Clayton Act, was passed in 1976. For the first time merging parties above a certain size were required to report their proposed transaction to the Commission and DOJ before the deal could be consummated. The law sets a relatively short limit on the time that the agencies may delay a proposed merger in order to investigate the parties and the industry, decide if there are potential competitive concerns, ask the parties for more information if necessary, and decide whether to oppose the transaction in court. But the "clock" on this time limit begins to run only when the firms have supplied all the information that the agencies need -- a critical incentive for getting the parties to cooperate. Before Hart-Scott-Rodino, parties were free to merge at any time, we might not learn about the deal until after it was done, and if we went to court, a decision might not come until years after the operations were totally integrated. Aside from the competitive harm that might occur in the interim, it was often hard to convince a court that a problem was serious enough to warrant the then drastic remedy of divestiture or recission.
I think it is also fair to point out that even with the benefit of pre-merger notification, the sort of analysis I outlined earlier does not come easy and does not come cheap. Even though there are threats to our budgets and we consider ourselves understaffed, between the two agencies we do have a force of lawyers and economists that is larger than most countries can afford. Furthermore, in the US virtually every industrial sector has at least one trade association and usually a separate trade publication that gather information about sales and production and often market shares. Our Department of Commerce and other agencies require companies to report a great deal of information about their operations. All of this information is readily available to us when we begin an investigation.
We also have a legal system that is based on the compulsory discovery of documents and testimony before trial and our past successes have created a climate where companies seldom challenge our subpoenas and usually respect our requests for the voluntary submission of information. Without these legal and practical resources our ability to conduct intensive investigations and sophisticated analyses would be severely compromised.
1. Although I represent the Federal Trade Commission, my remarks do not reflect an official position of the Commission and have not been endorsed by any Commissioner.