Mergers Acquisitions AntiCompetitive Business Practices Paul L Schumann

Background (Review) ¨ Competitive free market Capitalism is ethical because it: – Achieves utilitarian goal: maximizes net social benefits – Protects rights: the liberty and property rights of buyer and seller – Is fair: produces a fair distribution of benefits and costs (under Capitalist definition of Distributive Justice)

Background (Review) ¨ However, government regulation might be justified in order to: – Correct externalities – Protect other rights – Ensure fairness – Support caring ¨ But the advantages of free market Capitalism depend on competition

Perfect Competition ¨ Criteria include: – Numerous small buyers & sellers – Freedom of buyers & sellers to enter or leave the market – Perfect information of all relevant facts about the product or service ¨ Result: Buyers & sellers are protected by competition from exploiting each other

Threats to Competition ¨ Monopoly ¨ Oligopoly ¨ Anti-competitive practices

3 Major US Anti-Trust Laws ¨ Sherman Anti-Trust Act (1890) ¨ Clayton Act (1914) ¨ Federal Trade Commission Act (1914)

Sherman Anti-Trust Act (1890) ¨ Forbids: restraints of trade, monopolization, attempts to monopolize, and conspiracies to monopolize – Example of restraints of trade: price fixing ¨ Criminal statute – Violations can be felonies • Fines: corporations & individuals • Prison: individuals ¨ Civil lawsuits: treble damages

Clayton Act (1914) ¨ Forbids specific anti-competitive practices: – Mergers that tend to create a monopoly – Interlocking Boards of Directors among competitors – Exclusive dealing arrangements – Tying arrangements – Price discrimination (goods only, not services) ¨ Civil statute: no criminal penalties

FTC Act (1914) ¨ Forbids: – Unfair methods of competition – Unfair or deceptive acts or practices that affect commerce ¨ Civil statute: – Remedies: cease and desist orders

US Anti-Trust Enforcement 1. US Department of Justice (DOJ) Anti-Trust Division: – Headed by the Assistant Attorney General for Anti-Trust – Criminal actions under Sherman Act – Civil actions under Sherman or Clayton Acts – www. usdoj. gov/atr/

US Anti-Trust Enforcement 2. Federal Trade Commission (FTC): – Civil actions under Sherman, Clayton, or FTC Acts – Headed by 5 Commissioners: • • Staggered 7 -year terms of office Appointed by President of US Advice & consent of US Senate Maximum of 3 from one political party – www. ftc. gov/

US Anti-Trust Enforcement 3. Enforcement by state governments – Enforce state anti-trust laws – Enforce federal anti-trust laws by filing antitrust lawsuits

US Anti-Trust Enforcement 4. Private party civil lawsuits: – Party harmed by violation of anti-trust laws can sue in court – Injunctions – Treble damages

Anti-Trust Case Outcomes ¨ Drop the case: insufficient evidence of violation of the law ¨ Consent decree: – Negotiated settlement between company and government – No admission of guilt ¨ Court decision

Anti-Trust Remedies ¨ Monetary damages ¨ Injunctions: cease & desist orders ¨ Conduct remedies: – Limits on future actions – Continuing court oversight may be required ¨ Structural remedies: – Change structure of situation to prevent future violations – Reduces the need for continuing court oversight ¨ Sherman Act criminal cases: fines & prison

Threats to Competition ¨ Monopoly ¨ Oligopoly ¨ Anti-competitive practices

Monopoly ¨ 2 Key Characteristics: – Only one seller: 100% market share – Extremely high barriers to entry: • High capitalization costs – Example: electric power? • Patents – Example: pharmaceutical drugs ¨ Example: Does Microsoft have a monopoly with Windows?

Monopoly Economic Effects ¨ Control over prices: – Higher prices than would occur with competition – Higher profits for the monopolist

Monopoly Moral Effects ¨ Violates utilitarianism – Deadweight loss to society from higher prices – Inefficiency? ¨ Violates rights: restricted choices ¨ Violates justice: unfair to consumers

Monopoly Regulation ¨ Natural monopoly: regulate prices – Example: electric power? ¨ Government-granted monopoly through patents: limit length of patent protection – Example: pharmaceutical drugs ¨ Earned monopoly: regulate ability to use earned monopoly power to extend monopoly to new markets – Example: Microsoft?

Threats to Competition ¨ Monopoly ¨ Oligopoly ¨ Anti-competitive practices

Oligopoly ¨ 2 Key Characteristics: – Small number of sellers dominate the market – High barriers to entry ¨ Result: – Threat of collusion among sellers to act in unison: act as monopoly instead of competitors ¨ Government regulation: – Prevent collusion

Mergers ¨ Mergers can generate anti-trust concerns ¨ Mergers are thus subject to government regulation ¨ 3 types of mergers: – Horizontal merger – Vertical integration – Conglomerate merger

Horizontal Merger ¨ Competitors merge – Example: merger of Chevron & Texaco ¨ Anti-trust concern: might directly reduce competition significantly. To decide: – Define relevant product market – Define relevant geographic market – Examine effect of merger on market shares – Analyze barriers to entry ¨ Regulate merger terms & conditions

Vertical Integration ¨ Merger up or down the chain of production and distribution – Example: Merger of Time-Warner (content) & AOL (distribution) ¨ Anti-trust concern: might harm competition significantly – Why? Possibility of cut-off supply to the competitor. – Issue: Are there alternative sources of supply that are economically viable? ¨ Regulate merger terms & conditions

Conglomerate Merger ¨ Totally unrelated companies merge – Example: US Steel and Marathon Oil ¨ Rationale: diversification—“don’t put all your eggs in one basket” ¨ Anti-trust concern: deep pockets / internal cross-subsidization / may facilitate predatory pricing ¨ Regulate merger terms & conditions

Threats to Competition ¨ Monopoly ¨ Oligopoly ¨ Anti-competitive practices

Anti-Competitive Practices 1. Price fixing 2. Manipulation of supply 3. Exclusive dealing arrangements 4. Tying arrangements 5. Retail price maintenance 6. Price discrimination

1. Price Fixing ¨ Conspiracy by competitors to collude to raise prices – Example: Retail gasoline? – Effects: • • • Reduced competition based on price Higher prices Higher profits for the conspirators – Generally illegal (“per se” vs. “rule of reason”)

2. Manipulation of Supply ¨ Conspiracy by competitors to collude to reduce the supply of the product or service – Examples: • Market allocation conspiracies: illegal • OPEC – Effects: • Higher prices • Higher profits for the conspirators

3. Exclusive Dealing Arrangements ¨ Seller agrees to sell to a buyer on the condition that the buyer agrees not to buy from other sellers – Examples: • A gasoline refinery that sells to independent gas stations on the condition they agree to buy exclusively from the refinery • Mc. Donalds? • Microsoft pricing of Windows to computer manufacturers? – Achieves the effect of vertical integration without an actual merger – Effect: reduced competition – Illegal if it substantially reduces competition

4. Tying Arrangements ¨ Seller agrees to sell one item to a buyer on the condition that the buyer also buys another item – – – Example: Windows & Internet Explorer (IE)? Effect: reduced competition Illegal if: 1. 2 distinct products, and 2. Seller has market power for one of the products

5. Retail Price Maintenance ¨ Manufacturer agrees to sell to retailer on the condition that the retailer charges the retail price specified by the manufacturer – Example: TV manufacturer will only sell to a retailer if the retailer charges the retail price specified by the TV manufacturer – Effect: reduced price competition among retailers – Illegal: retail price maintenance agreements – Legal: refusals to deal

6. Price Discrimination ¨ Seller charges different prices to different buyers for identical goods – Example: Wal-Mart opens a store in a town and charges lower prices than it charges in other towns for the same merchandise? – Effect: may reduce competition – Illegal for goods, not illegal for services • Defenses: (1) cost or (2) meet competition

Price Discrimination by Airlines ¨ Example: MSP to ORD round trip fares: – $ 284 (21 day advance purchase, Saturday stay) – $ 882 (no advance purchase, no Saturday stay) ¨ Not illegal (transport is a service) ¨ Airlines say price discrimination necessary – Example: city Y to city Z costs airline $150 • 2 customers: person A will pay up to $50, person B will pay up to $100 • No price discrimination ($75), no flight

Bribery ¨ Bribery is another issue that raises anticompetitive concerns – Example: A company that wins a sale by paying a bribe to the purchasing agent of the buyer harms: • The buyer: doesn’t get the best deal • The competitor: doesn’t get the sale they’ve earned

Bribery, Extortion, & Gifts ¨ Bribe: I bribe you when I give you something of value in order to get you to do something that violates your moral duties – Example: bribe a police officer to avoid a traffic ticket that was deserved – Example: bribe a professor to get a better grade than was earned – Example: bribe a purchasing agent to get a sale that was not earned on the merits of the deal

Bribery, Extortion, & Gifts ¨ Extortion: I extort you when I coerce you to give me something of value by making an illegitimate threat against you – Example: pay me $1000 per month or else I’ll burn down your restaurant – Example: pay me $500 or else I’ll give you an “F” grade in the class even though you’ve earned a better grade than “F” – Example: purchasing agent extorts seller

Bribery, Extortion, & Gifts ¨ Gift: I give you a gift when I give you something of value without expecting anything in return from you that would violate your moral duties, and you have not illegitimately threatened me – “No strings attached” – Example: a professor brings candy for his or her students on Halloween

Questionable Payments ¨ Example (hypothetical!): The College Technology Committee spends 2 weeks in Hawaii paid for by Dell, at a total cost to Dell of $30, 000; the Committee later decides all Business students must buy laptops from Dell. – – – Has Dell given a gift to the Committee members? Or has Dell bribed the Committee members? Or has the Committee extorted Dell?

Questionable Payments ¨ Example (hypothetical!): Dell takes the College Technology Committee to lunch at Maggie’s, at a total cost to Dell of $60; the Committee later decides all Business students must buy laptops from Dell. – Has Dell given a gift to the Committee members? – Or has Dell bribed the Committee members? – Or has the Committee extorted Dell?

Bribe vs. Gift Guidelines 1. Value: Is the value substantial enough that 2. 3. 4. it’s likely to influence the recipient’s decisions? Purpose: Is the purpose to influence the recipient’s decisions? Circumstances: Is it given openly? Recipient’s Position: Is the recipient in a position to influence dealings with the giver?

Bribe vs. Gift Guidelines 5. Accepted Practice: Is it an open and well- known practice? 6. Company Policy: Does the company have a policy that forbids acceptance? 7. Law: Is there a law that forbids acceptance?

Foreign Corrupt Practices Act (1977) ¨ Forbids: payments to higher-level foreign government officials for the purpose of gaining business – – – Extensive accounting requirements to uncover bribery Corporate fines Individuals: fines & prison ¨ Does not forbid “grease” or “facilitating” payments to low-level foreign government employees to do routine (not illegal) functions