Review of Industrial Organization 12: 687–691, 1997.c 1997 Kluwer Academic Publishers. Printed in the Netherlands.

Comment on “Merger Policy in the United States”

F. M. SCHERER

Abstract. This paper comments briefly on a merger policy article by Dennis Mueller. It concurs withMueller’s judgment that X-efficiency consequences are of crucial relevance in developing a soundantitrust policy toward mergers. It agrees also that firms proposing mergers overstepping structuralguidelines should be permitted an efficiencies defense, but it stresses the difficulties of making exante efficiency predictions.

Key words: Mergers, antitrust.

The editors have asked me to write a short comment on Dennis Mueller’s returnto an arena in which he has done pioneering research. Not surprisingly, he hasfocused on a central point – what might best be called, following Leibenstein, theX-efficiency effects of mergers. We economists become so enamoured with theniceties of efficient resource allocation that we often lose sight of more importantthings. Merger policy in the United States during the past two decades has beenconcerned mainly with potential price-raising and resulting resource misallocationswhich, most studies (with one by Mueller and Keith Cowling as an exception) haveshown, typically entail quite modest efficiency losses. The concomitant incomeredistributions are much larger, but by tradition, economists shy away from thestrong value judgments required to assess them. Ignored more often than not isthe point Mueller’s literature review stresses: that mergers often lead to corporateculture mismatches and managerial breakdowns, so that, Mueller concludes, “themain social cost of many mergers is the damage to the efficiency of the firmsthemselves brought about by their merging”.

I know of no empirical finding in economics more bitterly disputed than thisone. My own research with David Ravenscraft, generously cited by Mueller as “themost ambitious of all : : : in terms of sample size, time span, and care in handlingthe data”, yielded conclusions similar to those of Mueller. One of the biggestdisappointments of my professional career has been the total neglect many, perhapsmost, students of merger effects have accorded our study. In my retrospective view,it was the most solid work I have carried out in 40 years of research. So confidentwere Ravenscraft and I of our analysis that when the Brookings Institution askedfor the names of potential manuscript reviewers, our second nominee on a list ofsix was Michael Jensen, leader of what was then the school that most stronglyopposed our findings. We were told he held the manuscript for many months butthen declined to comment, claiming a shortage of time. Yet he simultaneously

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changed his position 180 degrees, stating that the conglomerate mergers of the1960s and 1970s, far from being efficiency-enhancing, were a managerial disasterthat had to be undone by a new wave of bust-up takeovers. To the best of myknowledge, he and most of his “efficient takeover market” compatriots have paidno overt heed to our work, and they continue to argue from stock price event studiesthat corporate control changes – to be sure, in new and more hostile garb – are inthe net efficiency-enhancing.

My own view is more eclectic. The work by Ravenscraft and me focused onthe era when conglomerate mergers were fashionable and substantial horizontalmergers were prevented by tough antitrust enforcement. We found horizontal andvertical mergers on average to have more benign, but not significantly positive,effects. Divestitures in the form of LBOs or to firms already experienced in thebusiness (i.e., implying horizontal mergers) had strong positive effects. Studiescited by Mueller of non-U.S. experience weighted more heavily toward horizontalmergers have yielded generally equivocal effects. Some lean toward finding effi-ciency gains, some efficiency losses. Mergers clearly can enhance efficiency, asdiverse theories predict. But as theories rooted more in the sociology of organiza-tional behavior suggest, they can also degrade efficiency. It is hard to be sure whicheffect predominates.

One sorting factor deserves more attention than it has received in the litera-ture. Unless the principal rationale of corporate control changes is to “throw theincompetent rascals out”, making mergers that enhance efficiency requires a goodunderstanding of the would-be partner’s internal structure, strengths, weaknesses,and corporate cultures. Achieving the requisite insights usually requires a periodof pre-merger courtship in which the firms “level” with one another. I can think ofno environment less propitious to such information exchanges than that of hostiletakeovers. Yet I have regularly been surprised to observe, even for friendly merg-ers, how little the initiating partner has thought about exactly what it will do torationalize the two firms’ operations post-merger. One reason why the exchangeof pre-merger information and hence pre-merger planning are so imperfect is thatmanagement of the more passive partner wants its shareholders to receive the bestpossible price, and therefore has no incentive to reveal latent problems and muchincentive to overstate potential synergies. Moreover, the stringent disclosure man-dates under Securities and Exchange Commission regulations virtually compeldiscussion of a possible merger to be confined to a very few individuals sworn tosecrecy. Moving down the hierarchy to explore detailed rationalization possibilitieswould encourage rampant leaks.

The broader question for public policy is whether one should try, as Muelleradvocates, to sort out efficiency-increasing cases from the efficiency-reducing cas-es. Before addressing that issue, I must note that policy-makers in recent yearsseem to have lost sight of something accepted as conventional wisdom within theantitrust community during the 1960s and 1970s. From the evidence available then,it appeared that the X-efficiency effects of merger were pretty much of a wash.

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If mergers did not on average enhance efficiency, and if (a less clearly articulat-ed assumption) the specific types of mergers with which antitrust was concerneddid not on average enhance efficiency, then applying stringent antitrust criteriatoward mergers, and perhaps prohibiting many otherwise feasible acquisitions,were unlikely to have systematically adverse X-efficiency effects. And they mightarguably have positive allocative efficiency, distributive equity, and power decen-tralization effects. Therefore, the costs of a tough policy were at worst modest, andthere was the prospect, even if not the certainty, of appreciable benefits. Indeed, atough merger policy could force firms to focus their energies on achieving internalgrowth rather than growth by acquisition. Internal growth that passes the severetests of the market is almost surely in the net efficiency-enhancing. When for exam-ple Bethlehem Steel Corporation was prohibited in one of the first Celler-KefauverAct cases from expanding into the Midwest by acquiring Youngstown Sheet andTube, it built at Burns Harbor, Indiana, a green-field plant that was for a consider-able time the most technologically advanced integrated steel-making facility in theUnited States. Again, I see little recognition of these points in recent discussionsof merger policy.

Mueller observes that the logic of trading off adverse price-raising effects ofmergers against cost-reducing efficiency effects was first articulated in 1968 byOliver Williamson. It appeared to gain formal sanction with the inclusion of an“efficiencies” defense in the 1984 Merger Guidelines. To this I would add twoobservations. First, Williamson’s classic “economies” paper was either writtenwhile he was special assistant to the Assistant Attorney General for Antitrust orwas directly inspired by his one-year service (then the norm) in that position. Thus,it came from a locus where it could have been influential, but at first was not. Second,I was the economist for the respondents in the first litigated antitrust case that triedto implement the efficiencies defense.1 My impression from that experience wasthat the Department of Justice staff was reluctant to endure a courtroom test of thenew efficiencies guideline and attempted to limit severely the scope of the defense– e.g., requiring, contrary to Williamson’s analysis, that cost savings be passedon to consumers, refusing to consider cost savings that might result from superiormanagement, and insisting that each of the many capital investments supportingthe acquired firm’s efficiency gains be analyzed individually (at a prodigious costin trial time). To be sure, the Guidelines were written to guide internal decision-making within the antitrust agencies, not as a standard for in-court adjudication.As such, they enhanced the agencies’ administrative discretion so that close callson the traditional structural criteria might be approved without appearing to giveway on those criteria. Whether that is a good thing or not depends in part upon howmuch weight one places on having a government of laws rather than a governmentof men. This is a point to which I must return in evaluating Dennis Mueller’s policyproposals.

1 See the John F. Kennedy School of Government case study, “Archer-Daniels-Midland andClinton Corn Processing” (Cambridge: 1992).

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Mueller’s basic policy approach would significantly strengthen the structuralpresumptions against mergers, both horizontal and conglomerate, but at the sametime elevate the status of the efficiencies tradeoff to dispositive parity with thestructural indicia. The burden of proving efficiencies would be placed on themerging parties, and post-merger transparency would be maintained by requiringseparate reporting of the merged entities’ profit and loss statements and balancesheets for ten years after the merger took place.

This approach, like the prospect of hanging in a fortnight, would mightilyconcentrate the minds of would-be merger makers on the efficiency aspects of theirprospective union. That, I believe, would be a salutory development. I have doubts,however, about its feasibility, either under existing institutions or with the kind of“inquisitorial” procedures proposed by Mueller.

One basic problem is that, even with the best of cooperation between the merg-ing parties, the efficiency effects of merger are uncertain, and it would be difficultto offer anything that passes for convincing proof of prospective efficiencies. Thefamous New York Central – Pennsylvania Railroad merger of 1968, from which costsavings of 4 percent were projected, actually led to organizational chaos, bankrupt-cy, and ultimately, nationalization under Conrail. The acquisition of YoungstownSheet & Tube by Jones & Laughlin, on whose efficiency implications I wrote amemorandum for Attorney General Griffin Bell, did in fact lead to substantialoperating efficiency improvements. But they were realized in ways rather differentfrom what had been forecasted before the merger. The Archer-Daniels-Midlandacquisition of Clinton Corn Processing Co., on which an efficiencies defense waspresented in court, took place seven years before a trial on the merits occurred, andtherefore it was possible to analyze what actually happened and why, and not justspeculate over what might happen in the future. One possible solution suggested bythe ADM case would be to evaluate the prospective merger efficiencies in advance,and then, if they seemed persuasive, give the merging parties five years in whichto prove that they can actually effectuate them. If they do not, the merger wouldbe undone. The difficulty with this approach is that it precludes scrambling themerging parties’ operations and extensive plant closures, which might limit theextent to which efficiencies can be realized.

To evaluate projected or actually realized efficiencies under a merger efficien-cies defense would require antitrust enforcement agency skills different from thosethe agencies currently possess. Agency staff economists perform ably in analyzingmarket boundaries, substitution among products, and pricing behavior – mainstaysof the current enforcement focus. But they also conform all too well to WassilyLeontief’s definition (in a graduate economic theory lecture at Harvard) of an indus-trial organization economist as a person who has never been inside a factory. Asgraduate training in industrial organization becomes increasingly model-orientedand less case study-oriented, the mismatch between economists’ skills and whatwould be required for efficiency evaluations can only increase. Attorneys have theirown unique skills, but they do not include the detailed analysis of scale economies,

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plant-specific and product-specific, and the technological and organizational deter-minants of productivity. To analyze merger efficiency claims intelligently, theantitrust agencies would have to recruit able young people with solid managementconsultant experience and/or training equivalent to what one receives in a goodtechnology-oriented MBA program – talent commanding high salaries in currentmarkets.

An inquisitorial agency of the sort Dennis Mueller proposes will not solve theseproblems unless it acquires the needed new talent. There are other difficulties too inMueller’s approach. It would presume that a structural violation exists, triggeringthe possibility of an efficiencies defense, from the kinds of information obtainedunder the Hart-Scott-Rodino pre-merger notification law. But usually, having suchinformation only sets the stage for a debate. Market share statistics are no better thanthe market definitions on the basis of which they are computed. When merger casesare discussed informally before antitrust agency staff and when, absent agreement,they enter litigation, a key point of contention is usually the market definitionsMueller assumes agencies can ascertain unilaterally. Costly though it may be, todeprive firms of the opportunity to contest the agency’s definitions would be anabridgement of due process.

Mueller offers the Federal Trade Commission as an exemplar well-suited toperform his “inquisitorial” function. As an FTC staff veteran, I am less certain.Typically, the economic, business, and technological expertise of the commission-ers leaves a fair amount to be desired. And if a matter is sufficiently important andheatedly disputed to go into litigation, the FTC’s procedures are, if anything, morecumbersome than those of the federal courts, to which the Department of Justicehas direct recourse.

Thus, I end up, as is often the case, uncertain and torn. I believe with Muellerthat X-efficiency is a more important merger concern than allocative efficiency.I believe that too little thought is devoted pre-merger as to how the mergingparties will derive efficiencies from their action. Offering an efficiencies defensefor mergers that transgress strict market structural limits would focus the attentionof the merger-makers on that important question and, less certainly, help separateout the chaff from the wheat. But I doubt whether the U.S. antitrust enforcementagencies, encumbered by myriad staff recruitment constraints and the requisites oflegal due process, have the ability successfully to sustain their part of the bargain.