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Monday, September 30, 2013

Should the Philadelphia National Bank Presumption Be Abandoned or Allowed to Evolve?

Should the Philadelphia National Bank Presumption Be Abandoned or Allowed to Evolve?; Reflections on Commissioner Wright’s Speech

Jonathan B. Baker & Steven C. Salop

 

In a recent speech, FTC Commissioner Joshua D. Wright called on courts to abandon the presumption established in Philadelphia National Bank (PNB) that mergers of rival firms with high market shares in concentrated markets harm competition.  We previously have written on this topic and wanted to comment on his proposal and suggest an alternative. We think that presumption should not be abandoned, but should continue to evolve.

First, in the fifty years since PNB, competitive effects analysis has evolved in economics and the courts and, as a result, the almost-irrebuttable presumption applied in that decision has eroded.  Today the presumption is both much weaker and rebuttable. The 1990 Baker Hughes opinion by the DC Circuit panel (which included future-Justices Ginsburg and Thomas) invited lower courts to undertake a wide-ranging and thorough economic analysis of the likely competitive effects of a transaction in which market concentration is just one of many relevant factors. The opinion explained that “Section 7 involves probabilities, not certainties or possibilities” and that market concentration “simply provides a convenient starting point for a broader inquiry into future competitiveness.”  The subsequent DC Circuit panel in Heinz also expressly rejected the contention that high concentration in a market with entry harriers alone entitles the government to a preliminary injunction, even in reviewing a “3 to 2” merger.  They accepted that a successful rebuttal requires evidence showing that the market share statistics provide "an inaccurate account of the [merger's] probable effects on competition," and recognized the possibility that an efficiencies defense could prevail. 

Second, the Heinz opinion also decisively rejected the view that concentration is irrelevant once the merging firms proffer evidence to rebut the government's prima facie case. According to the court, a rebuttal premised on the presence of "structural market barriers to collusion" in a merger to duopoly requires proof that tacit collusion is more difficult to achieve or maintain than in other industries. The more substantial weight accorded concentration in Heinz relative to Baker Hughes also appears to derive from the court's skepticism about the efficiency defense proffered by the merging firms.  Thus, it should not be interpreted as a rejection of Baker Hughes or a reversion to a 1960s interpretation of the structural presumption.  Instead, it reflects further evolution of the presumption.

Third, this evolution is consistent with modern economics.  Economic theory and empirical evidence certainly do not suggest ignoring market shares and concentration in merger analysis. There are several issues here.

  • A wide range of theories of oligopoly conduct — both static and dynamic (supergame) models of firm interaction — is consistent with the view that fewer firms and more concentrated markets on average are associated with higher prices.  In general, the smaller the number of firms, the more likely the firms will be able to reach a mutually satisfactory outcome at a higher-than-competitive price.  Unilateral price increases or output restraints also are more likely to be profitable when the merged firm has a higher market share, ceteris paribus.  Accordingly, a horizontal merger reducing the number of rivals from four to three, or three to two, would be more likely to raise competitive concerns than one reducing the number from ten to nine, ceteris paribus.

 

  • The empirical evidence is consistent with a weak positive relationship between
    market concentration and price.  (Although few economists today would accept an older view defending the structural presumption based upon a claimed relationship between market concentration and industry economic profits, the conclusion is different with respect to the thesis that concentration is related to price.)  The studies finding a relationship between concentration and price are imperfect.  (They do not always define markets properly, or adequately account for the reverse effect of price on concentration, for example.)  And, it certainly is true that collusion does not occur in every highly concentrated market while collusion sometimes does succeed in markets that are not so highly concentrated.  Still, Professor Richard Schmalensee's 1989 summary in his chapter in the Handbook of Industrial Organization remains a reasonable interpretation of the empirical studies: "In cross-section comparisons involving markets in the same industry, seller concentration is positively related to the level of price."

 

  • At the same time, the empirical evidence makes it clear that other industry-specific and market-specific factors beyond concentration are also important in determining the competitive effects of mergers.  While a presumption based on market shares and concentration has an economic basis, other factors also go into determining the intensity of competition, including entry conditions, the similarities or differences among firms and their products, the size of buyers, and others.  Moreover, the empirical research does not reliably identify any particular concentration level common across industries at which price increases kick in.

 

  • These caveats do not mean that concentration is irrelevant.  Studies have found that in some industries, increases in concentration, particularly substantial ones, may generate large increases in prices.  Accordingly, contemporary economic learning on the relationship between market concentration and price suggests that concentration be considered when undertaking competitive effects analysis — in conjunction with other factors suggested by the competitive effects theory – but not treated as an irrebuttable determinant of post-merger pricing.

This understanding of both law and economics is generally consistent with the way that the Merger Guidelines handle concentration in merger analysis today.  We think that the approach of the 2010 Horizontal Merger Guidelines is correct, and that it is neither necessary nor advisable  to
eliminate the current structural presumption from the case law, as it has been expressed by the D.C. Circuit.   In saying this, we certainly are not calling for a return to a mechanical,concentration-based approach to merger policy.  We support the Guidelines’ approach of describing the more detailed factual showings that would indicate whether a proposed horizontal merger would likely create various types of adverse competitive effects, coordinated or unilateral.  

Commissioner Wright is also concerned that the PNB presumption is sensitive to market definition.  A presumption based on market shares does require a market to be defined.  The 2010 Merger Guidelines recognize the imperfections and uncertainties inherent in market definition.  For this reason, we are skeptical of a merger policy that would overweight market shares and concentration.  However, Commissioner Wright’s proposal to totally eliminate any structural presumptions because of these imperfections comes at a cost that he does not address.  

As a matter of logical consistency, if he proposes to discard presumptions based on concentration and market shares on this basis, Commissioner Wright also must necessarily discard the safe harbors based on low HHIs or market shares.   This door swings both ways.   Flawed market definition can lead to erroneous low shares as well as erroneous high shares.     

Policy and legal presumptions are useful, so we are reluctant to eliminate any role for safe harbors and anticompetitive presumptions in merger analysis.  We think it is appropriate to update the presumptions to keep up with the evolution of competitive effects analysis.  The 2010 Merger Guidelines have taken steps down this road.  One evolutionary change involves  basing a safe harbor and anticompetitive presumption in unilateral effects cases on the closeness of substitution between the merging parties and price-cost margins (e.g., based on measures of upward pricing pressure). (For example, see Salop and Moresi.) 

Section 6.1 of the 2010 Merger Guidelines incorporate  a quasi-safe harbor in unilateral effects
cases based on the gross upward pricing pressure index (GUPPI), as described by then-Deputy AAG Carl Shapiro (p.727).  (In a speech while he was Deputy AAG, Shapiro also specified a GUPPI safe harbor of 5%.)  Another evolutionary change incorporated in Section 7.1 of the 2010 Merger Guidelines recognizes an anticompetitive presumption in coordinated effects cases when one of the merging firms is a “maverick” in a market vulnerable to coordination. (For further discussion, see
Baker and Shapiro.) 

In short, we think that the PNB-style structural presumptions should continue to evolve, rather than be abandoned. 

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