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The Coordinated Effect of a Merger with Balanced Sharing of Collusive Profits

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Abstract

It is hard to assess the coordinated effect of mergers in solid and convincing fashion, in part because economic theory deals mainly with the sustainability of tacit collusion and generally does not explore the conditions that foster collusion in the first place. Also the most popular schemes of collusion (Joint profit maximization and Nash Bargaining) proposed by the economic literature seem at odds with the evidence recorded on cartels and with the practical attitude of entrepreneurs. In this scenario the recent version of the Horizontal Merger Guidelines contained the interesting suggestion to pay attention to the process - parallel behaviour – which leads to collusive equilibria. Working on the same intuition we propose an approach based on the idea that firms can always find a feasible collusive agreement, for every possible value of the factor which discounts future profits. Assuming that in order to collude, firms demand the fair sharing of collusive gains, we exploit the egalitarian property of grim trigger strategies when all incentive compatibility constraints are binding. This approach suggests using three indicators to determine whether and how a merger affects the probability of collusion. An application of this approach to a real-world case (the AT&T/T-Mobile merger) is provided.

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Notes

  1. In Europe, for example, since the Air Tour/First Choice case, the standard of proof established by the lower court has become so demanding that it is virtually impossible, using current analytical and empirical tools, to veto a merger on the basis of creation of a collective dominant position. It appears to be considerably easier to assess the strengthening of an already existing collective dominant position (Sony/BMG, Impala).

  2. A promising line of research regarding how firms can reach supra-competitive equilibria in a framework characterized by tacit collusion has been proposed by Harrington (2012)

  3. That is, the combination of collusive, cheating and Nash Equilibrium profits that must be measured against the current discount factor in order to evaluate incentives to collude (see hereafter).

  4. Because critical discount factors depend on the discount factor.

  5. Baker gives the example of US airline tariffs. In 2000 Continental Airlines took the initiative in applying a fuel surcharge of $40 or $20 for flights longer or shorter than 1000 miles. Five other companies immediately did the same, but not Northwest, American West or Southwest. This turned out to be decisive in forcing Continental to abandon the price increase. Continental later made another attempt, with the same outcome. After the second attempt, Northwest launched an increase in the fuel surcharge of the same amount, modulated not by distance but between tourist and business class. This increase was applied immediately by the other companies (except Southwest) and remained in effect. Baker cites this as a good example of the role a maverick firm can play in conditioning competitors’ choices.

  6. Despite these limitations, if carefully employed the maverick firm approach can be extremely useful. For example, a recent European merger clearly involved a maverick firm and should probably have been forbidden because of its coordinated effect (case No Comp/M4919- Statoilhydro/ConocoPhillips, 21/10/2008). Regrettably, it was assessed only in relation to the unilateral effect and cleared subject to conditions. Another interesting example is the Anheuser-Bush/Modelo merger (DoJ, 2013).

  7. For an appraisal of the factors affecting tacit collusion, see Ivaldi et al. (2003).

  8. We cannot ignore, however, that the most innovative section of the guidelines concerns quantitative methods (e.g. Upper Pricing Pressure Test; UPP) for the direct evaluation of the unilateral effect of a merger. This novelty triggered a vociferous debate over whether the market definition should be dispensed with. The fact that the depiction of an antitrust market is still an indispensable preliminary to evaluating the coordinated effect (and as such must be retained in any case) went largely unnoticed. For example, Coate and Fischer (2010) made the case for retaining the stage of market definition: strangely, however, the reasons cited did not include its pivotal role in coordinated effect assessment. This “forgetfulness” is also found in the contributions by Carlton and Israel (2010a) and Carlton and Israel 2010b), an attitude that reveals a sort of Freudian denial of this type of assessment on the part of eminent antitrust scholars. Early articles on the recent guidelines also fail to refer to the coordinated effect (e.g. Shapiro 2012; Stone and Wright 2011).

  9. This possibility is now explicit. However partial collusion could be considered also under former Guidelines as long as the standard test was (and it still is) the “the substantial lessening of completion”.

  10. Markham (1951); Rotemberg and Saloner (1990); Deneckere and Koveneck (1992); Mouraviev and Rey (2011)

  11. Worldcom/Spring and Alcan/Pechiney (see Shapiro 2010)

  12. This hypothesis is also contradicted by empirical evidence: “Most cartel studies report that prices increased with the creation of the cartel and a very small number find that prices reached the joint profit maximization level” (Levenstein and Suslow 2006).

  13. Harrington 2006, p.25; Fabra and Motta 2013,p.48.

  14. It is true that the attention paid by colluders to market shares and to all possible types of parallel conducts can be interpreted, as part of literature does, as an efficient tool for monitoring the adherence to collusive agreements, rather than motivated by genuine distributive attitudes. It is not crucial to discriminate between these two possible causes as what really matters it is the presence of a balancing element in the distribution of extra-gains from collusion (Genesove and Mullin 2001).

  15. Levenstein and Suslow 2006, p.71; Harrington 2006, p.57.

  16. Osborne and Pitchik (1983); Schmalensee (1987); Bae (1987); Harringhton (1991); Fershtman and Pakes (2000); Kuhn (2004)

  17. It has been observed that Nash bargaining equilibrium can be interpreted as the end of a process of mutual concessions. The firm with the greatest gain from negotiation is the one which gives concessions; each concession makes the Nash product higher. That is why the end of the process corresponds to the Nash equilibrium (Harsanyi 1977 and 1987).

  18. Stigler (1964),p.45.

  19. Examples regarding this type of collusion are reviewed in Scherer and Ross (1990) and more recently in Marshall et al. (2008)

  20. Davis (2005), Kuhn (2004), Compte et al. (2002)

  21. The example involves two hypothetical mergers between two one-product firms (1 + 2 and 1+ 3), leaving only two competing firms on the market. Marginal costs of all firms are equal to 1 and their linear demand functions are:

    Q1= 22–9 p1 + 6.9 p2 + 2 p3

    Q2= 31 + 6.9 p1–9 p2 + 2 p3

    Q3= 9 + 2 p1 + 2 p2–5 p3.

  22. Such schemes do not comply with the feasibility criteria.

  23. See also Friedman 1977 (p.176) and 1986 (p.118).

  24. For comments on this function see Motta (2004) and Martin (2002).

  25. In the following examples, α = 120.

  26. See Sabbatini (2006, p.28–31)

  27. In fact, it is not a proper estimation, as all parameters are deduced from known or assumed values.

  28. The main input and assumptions are shown in Annex A.

  29. The fact that one of the main concerns of DoJ was the unilateral effect of the merger implies that probably our assumption does not fit the reality perfectly.

  30. Kwoka (2013) and Ormosi et al. (2015)

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Authors and Affiliations

  1. Italian Competition Authority, Piazza Verdi 6/a, 00153, Rome, Italy

    Pierluigi Sabbatini

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  1. Pierluigi Sabbatini
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Correspondence to Pierluigi Sabbatini.

Additional information

The views expressed in the paper are those of the author and do not involve the responsibility of the Authority. The paper benefited from long and proficuous discussions with P. Davis and comments on earlier drafts from F. Decarolis, D. Gärtner, C. Huse, D.Terlizzese and G. Werden. On request, the author will provide the Matlab codes to calculate the 3 indicators of the coordinated effect.

Annex A - AT&T / T-Mobile merger : Data Used for the Assessment

This case has been commented extensively by Besen et al. (2013); Grunes and Stucke (2011) and Moresi et al. (2011).

Annex A - AT&T / T-Mobile merger : Data Used for the Assessment

Input

  1. 1)

    Market share (postpaid):Verizon (0. 39 ), AT&T (0.32), Sprint (0.18), T-Mobile (0.11)

Information from Moresi et al. (2011), p.25–26; MRSS)

  1. 2)

    Prices: Verizon ($52.9 ), AT&T ($62.3 ), Sprint ($55 ), T-Mobile ($52)

Average revenue per user in the postpaid segment reported in Besen et al.(2013, p.5)

  1. 3)

    Market Output (number of postpaid customers): 213 million.

Information provided by Federal Communication Commission (2013, p.159).

Assumptions

  1. 1)

    Demand substitutability pattern in proportion to market shares (as in MRSS)

  2. 2)

    Retention ratio: 0.8 (one of the values proposed in MRSS)

  3. 3)

    Margin: 0.4 for all firms (MRSS, p. 26)

  4. 4)

    Linear demand structure (as in MRSS)

  5. 5)

    Bertrand-Nash equilibrium before the merger

Demand Structure

Based on this information (and assumptions) we derive the following demand structure for the four competitors:

Verizon = 120.614–3.54726 Pver + 1.2262 Patt + 0.470333 Pspr +0.745718 Ptmo.

AT&T = 101.604 + 1.48869 Pver - 2.6725 Patt + 0.385914 Pspr + 0.611871 Ptmo.

Sprint = 37.3832 + 0.511736 Pver + 0.345853 Patt −1.34166 Pspr + 0.210331 Ptmo.

T_Mobile = 59.8989 + 0.837387 Pver + 0.565941 Patt + 0.217077 Pspr −1.9599 Ptmo.

Costs.

From prices and margins we derive the following (marginal) costs:

Verizon = 31.7; AT&T = 37.5; Sprint= 31.2; T_Mobile = 33.

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Sabbatini, P. The Coordinated Effect of a Merger with Balanced Sharing of Collusive Profits. J Ind Compet Trade 16, 345–371 (2016). https://doi.org/10.1007/s10842-016-0227-y

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