Tuesday, September 18, 2018

Profit Margins Rather Than Concentration to Measure Merger Effects

A recent article in GCR on Agency economists see profits as antitrust concern has me thinking about corporate finance and M&A in a way that is distinct from IO antitrust analysis.  Do higher profit margins mean that certain industries or firms have higher monopoly rents?  Not necessarily.

Profit margins may mean very different things in different industries, and we would expect cross-industry differences independent of market concentration/competition.  Two other issues come to mind. First, even in the same industry, net profit margins (measured simply as net income/sales) also vary with leverage -- all else equal, companies with a higher percentage of debt will have lower accounting-based profit margins (although their economic profits would not necessarily be lower). Second, companies with high accounting-based profit margins are not necessarily generating large economic rents if they regularly have a high required level of net investment. For example, a cable company or cell phone company may have to continually make large capital investments, which means that the free cash flow they actually generate for their investors may not be that large even in those cases when they have what might appear to be high profit margins.


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