Chapter 26. Corporate Mergers and Antitrust

Chapter 26Corporate Mergers and Antitrust26-1Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Chapter ObjectivesThe explanation of antitrustMajor antitrust lawsModern antitrustTypes of mergersThe effectiveness of antitrustThe trend toward bignessThe Microsoft case26-2Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.A Historical Perspective on Corporate ConcentrationThe history of the American economy since the Civil War has been one of growing corporate concentrationLike tides, this concentration has had its ebbs and flowsDuring the last century and a quarter, a few hundred companies came to dominate our economy26-3Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.AntitrustThe political backgroundDuring the 19th century the federal government rarely intervened in the economyThere were, however, two major forms of intervention, both of which were key issues in the events leading up to the Civil Warhigh protective tariffs the transcontinental railroad26-4Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Political BackgroundAt various times the government passed a high protective tariff that made imports more expensive and greatly aided northern manufacturersThis forced the south to pay much higher prices for the foreign goods they neededThe transcontinental railroad, was built with tremendous amounts of federal aid and it completely bypassed the southBoth policies were benevolent to big business, so few protests were raised about government intervention in the economy26-5Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Political BackgroundThe late 19th century was the era of the “trust”Trusts were cartels that set prices and allocated sales among their member firmsThe most blatant were in oil and sugarOthers were in meat packing, cottonseed and linseed oil, lead, leather, whiskey, tobacco, electrical tools, coal, steel, and the railroads26-6Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Political BackgroundTypical attitudes of the trustThe great financier J. P. Organ proclaimed, “I owe the public nothing”Railroad tycoon Billy Vanderbilt said, “The public be dammed, I am working for my stockholders”26-7Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Sherman Antitrust Act In 1890 congress passed the Sherman Antirust Act to curb the trust movementBut the language of the law was left rather vagueFinally, after years of preparation by the Roosevelt (TR) and Taft administrations, suits were brought against Standard Oil and American TobaccoThese companies were broken up by the court, not because they were big but because they were bad26-8Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Rule of ReasonThe Supreme Court’s decision breaking up Standard Oil and the American Tobacco Company was based on what they called its “rule of reason”Bigness itself was not an offense as long as that bigness was not used against rival firmsThis was in effect saying that the wolf not only had to be big and bad, but he actually had to blow the house down before he broke the law 26-9Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Clayton Antitrust ActThe Clayton Act, passed in 1914, prohibited practices that lessened competition or tended to create a monopoly26-10Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Clayton Antitrust ActThe Clayton Act prohibited five business practices when their effect was to “substantially lessen competition or tend to create a monopoly”Price discriminationInterlocking stockholdingInterlocking directoratesTying contractsExclusive dealingsThe Clayton act also expressly excused labor unions from prosecution under the Sherman Act26-11Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Federal Trade Commission Act (1914)The Federal Trade Commission (FTC) was set up as a watchdog against the anticompetitive practices outlawed by the Sherman and Clayton actsThe courts stripped most of its powers by the 1920sIn 1938, the Wheeler-Lea Amendment gave the FTC what has become its most important job: preventing false and deceptive advertisingIn recent years the FTC has been playing a more active role in approving or disapproving mergers26-12Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Modern AntitrustAntitrust enforcement evolved over the last century, growing more stringent or lax, depending on the presidential administration as well as the political leaning of the Supreme Court justices and the judges sitting in the lower federal courtsIn Europe, enforcement varied from country to countryThe formation of the 15-member European Union has resulted in a more unified approach to antitrust, especially since 199726-13Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Partial Breakdown of the Rule of Reason The membership of the Supreme Court changed radically during the Roosevelt (FDR) and Truman administrationsIn a landmark 1945 decision, the Court found that the Aluminum Company of America (Alcoa) which held 90% of the aluminum market, was an illegal monopolyThis decision eclipsed the “rule of reason”Alcoa lost because they were big, not because they were both big and bad26-14Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The 60% RuleWhat has apparently evolved from past antitrust decisions is what might be called the “60% rule”“Should a firm have a share of at least 60% of the relevant market and should that firm have behaved badly toward its competitors, it would then be subject to prosecution” Whether a firm would be prosecuted would depend on the political and economic outlook of the current administration and the outlook of the nine Supreme Court justices 26-15Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Four Landmark CasesXeroxAT&TIBMMicrosoft26-16Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Four Landmark CasesXeroxThis case hinged on whether the relevant market was all paper copiers (less than 50% of the market) or just plain paper copiers (close to 100% of the market)Xerox agreed to license its patents to its competitorsBy this time Japanese competitors were also entering the American market causing Xerox’s market share to fall below 50% 26-17Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Four Landmark CasesAT&TAT&T was accused of having a monopoly on local phone service (which it could hardly contest) and of making it hard for long-distance competitors to use its local phone networkAT&T was allowed to keep its long-distance service in exchange for giving up its 22 local phone companiesAT&T was also allowed to enter the telecommunications-computer field26-18Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Four Landmark CasesIBMOriginally initiated in 1969, this suit continued for 13 years until the Reagan Justice Department decided to drop itBetween 1969 and 1982 IBM had about 70% of the mainframe computer marketBut the word processor and minicomputer markets had become an important segment of the overall computer market during this periodThus the Justice Department reasoned that the changing computer market made IBM’s dominance in mainframes much less relevant 26-19Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Four Landmark CasesMicrosoftThis case has bounced around since 1995The Microsoft operating system runs on more than 90% of the 100 million PCs sold in the world each yearThe Justice Department was concerned that the company would use this virtual monopoly to force computer makers to use software products it might create in the future, further extending that monopolyMicrosoft’s growing market power has enabled the company to crush competitors, eliminating competition and innovation, and probably harming consumersIn April 2000, the court ruled against MicrosoftMicrosoft appealed its breakup, thus the breakup order remains on holdThe court’s restrictions on Microsoft’s conduct is not on hold while its appeal proceeds26-20Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.European Antitrust Antitrust enforcement in the European Union is conducted by the European Commission, which not only approves or prohibits mergers between Europe-based corporations, but also plays an increasingly important antitrust role with respect to other corporations doing substantial business in Europe While they have no power over mergers between American firms, they do have the power to make it difficult to do business in Europe26-21Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Types of MergersHorizontal mergersVertical mergersConglomerate mergers26-22Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Horizontal MergersHorizontal mergersA horizontal merger is the more or less conventional merger of two firms in the same industryUsually a larger firm swallows a smaller oneThe legal problem with horizontal mergers is that they appear to violate the Sherman Antitrust Act by lessening competition26-23Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Vertical MergersVertical mergersA vertical merger occurs when firms that have been engaged in different parts of an industrial process or in manufacturing and selling join togetherSome examples areWalt Disney’s acquisition of ABCThe purchase of Time Inc. by Time Warner communications (originally known as Warner Brothers) 26-25Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.Conglomerate MergersConglomerate mergersA conglomerate merger occurs when two companies in unrelated fields join togetherConglomerating has several advantagesIt can provide ready-made markets for the goods and services produce by various divisionsThe very diversity of the company is insurance against economic adversityThere are also tax advantages in conglomeratingConglomerating sometimes does not work out wellThe companies do not mesh and inefficiencies often result 26-25Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.How Effective Is Antitrust?What do we want antitrust to do?If we want to create something approximating perfect competition, antitrust has failed miserablyIf we would like to prevent further oligopolization of American industry, it has been a qualified successWithout antitrust things could have been a lot worseThere would have been no legal means to curb any mergers whatsoeverMany firms hesitate to merge because they are fairly certain the Justice Department would take legal actionThe whole focus of antitrust policy has been on mergers and not on firms that generate their own growth 26-26Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.The Trend Toward BignessBy and large American business is steadily becoming more and more concentratedMergers are part of a worldwide trend which shows no signs of slowing downThe distinction between American and foreign companies is becoming blurredMultinational corporations are becoming more commonBecause markets are global, few companies are reaching the size and scale that should cause concern about monopoliesHow does one nation, even the United States, enforce its antitrust laws in the global market place?26-27Copyright 2002 by The McGraw-Hill Companies, Inc. All rights reserved.