Making European Merger Policy More Predictable

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3 Making European Merger Policy More Predictable

4 Making European Merger Policy More Predictable By Stefan Voigt University of Kassel, Germany and André Schmidt University of Göttingen, Germany

5 A C.I.P. Catalogue record for this book is available from the Library of Congress. ISBN (HB) ISBN (e-book) Published by Springer, P.O. Box 17, 3300 AA Dordrecht, The Netherlands. Sold and distributed in North, Central and South America by Springer, 101 Philip Drive, Norwell, MA 02061, U.S.A. In all other countries, sold and distributed by Springer, P.O. Box 322, 3300 AH Dordrecht, The Netherlands. Printed on acid-free paper All Rights Reserved 2005 Springer No part of this work may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, microfilming, recording or otherwise, without written permission from the Publisher, with the exception of any material supplied specifically for the purpose of being entered and executed on a computer system, for exclusive use by the purchaser of the work. Printed in the Netherlands.

6 TABLE OF CONTENTS Preface xi CHAPTER I: PREDICTABILITY AS A CRUCIAL CONDITION FOR ECONOMIC GROWTH AND DEVELOPMENT 1 1. Introductory Remarks 1 2. Some Theoretical Considerations Concerning Predictability 1 3. Some Empirical Results Concerning Predictability 3 4. The Predictability of European Merger Policy A Survey Amongst Large European Firms Before Notification After notification Proposals for Improving Predictability 11 CHAPTER II: DEVELOPMENTS IN COMPETITION THEORY Introductory Remarks The Harvard Approach Main Points Policy Implications Critique The Chicago Approach Main Points Policy Implications Critique Contestability Theory Main Points Policy Implications Critique The Contribution of Game Theory: the New Industrial Organisation Game Components Advantages of Using Game Theory in Competition Theory Critique Concerning the Use of Game Theory in Competition Theory 27 v

7 vi TABLE OF CONTENTS 6. The Contribution of The New Institutional Economics: Transaction Cost Economics Transactions and Transaction Costs Assumptions of Transaction Cost Economics Policy Implications In lieu of a summary: Consensus and Dissensus Between the Various Approaches 34 CHAPTER III: TRENDS IN THE BUSINESS ENVIRONMENT Liberalisation as a Driving Force of Globalisation General Trends Liberalisation within nation-states Liberalisation by regional integration Liberalisation on a worldwide scale Sector-Specific Liberalisation Liberalisation of goods markets Liberalisation of capital markets Facilitation of Foreign Direct Investment Liberalisation of service markets Economic and Technological Factors Rapid Technological Change Increasing Mobility of Supply Developments in Transport Costs The Internet Homogenisation of Preferences Rapid Change of Consumption Patterns Conclusions 50 CHAPTER IV: POSSIBLE CONSEQUENCES OF TRENDS IN THEORY (B) AND DEVELOPMENTS IN BUSINESS (C) FOR COMPETITION POLICY Introduction From Market Definition to Assessing Dominance The Standard Approach The relevant product market The relevant geographic market 56

8 MAKING EUROPEAN MERGER POLICY MORE PREDICTABLE vii Defining relevant markets in practice: the hypothetical monopolist test Predicting the post-merger structure Assessing Single Dominance Consequences of Recent Theoretical Developments Consequences of Recent Trends in Business Environment Current EU Practice The Relevant Product Market The Relevant Geographic Market Assessing Dominance Proposals Towards Enhancing Predictability Simple Tools 72 Delineate Relevant Market Taking Both Demand and Supply Side Into Account 72 Reliance on Quantitative Methods to Delineate the Relevant Market 73 Reliance on Quantitative Methods to Assess Dominance 75 Some Critical Remarks Concerning Quantitative Techniques 76 Assessing the Importance of Customer Loyalty for Delineating the Relevant Market More Systematically Improvements Due to Theoretical Developments 79 Take Efficiencies Explicitly into Consideration 79 Assess Importance of Asset Specificity 84 Assess Importance of Uncertainty 85 Assess Importance of Frequency Improvements Due to Trends in the Business Environment 86 Taking the time dimension adequately into account 86 Taking the geographic dimension adequately into account A Closer Look at Barriers to Entry and Contestability The Standard Approach 87 State-Mandated Barriers to Entry 89 Structural Barriers to Entry 89 Strategic Barriers to Entry Consequences of Recent Theoretical Developments Consequences of Recent Trends in the Business Environment Current EU Practice Proposals Towards Enhancing Predictability 97

9 viii TABLE OF CONTENTS 4. Assessing Collective Dominance Standard Approach Recent Theoretical Developments Recent Trends in the Business Environment Current EU Practice Reform Proposals 113 CHAPTER V: CASE STUDIES Assessment of Barriers to Entry in European Merger Control: The Cases of Volvo/Scania, Mercedes-Benz/Kässbohrer, and MAN/Auwärter Barriers to Entry in the Case of MERCEDES-BENZ/KÄSSBOHRER Barriers to Entry in the Case of VOLVO/SCANIA The Market for Heavy Trucks The Market for Buses MAN/AUWÄRTER Economic Assessment Assessment of Barriers to Entry in European Merger Control: The Cases of SCA/Metsä Tissue and SCA Hygiene Products/Cartoinvest Barriers to Entry in SCA/METSÄ TISSUE Barriers to Entry in SCA HYGIENE PRODUCTS/CARTOINVEST Comparison of the Decisions Economic Assessment Assessment of Barriers to Entry in European Merger Control: The Case of BASF/Bayer/Hoechst/Dystar Barriers to Entry in the Case of BASF/BAYER/HOECHST/DYSTAR Economic Assessment The Assessment of Barriers to Entry in European Merger Control: The Markets for Telecommunications in the Case of Telia/Telenor The Special Conditions for Entry in the Markets for Telecommunications The Case of TELIA/TELENOR Assessment of the Decision Collective Dominance under the European Merger Regulation NESTLÉ/PERRIER (1992) KALI&SALZ/MDK/TREUHAND (1993) GENCOR/LONRHO (1996) EXXON/MOBIL (1999) AIRTOURS/FIRST CHOICE (1999) 154

10 MAKING EUROPEAN MERGER POLICY MORE PREDICTABLE ix 5.6. UPM-KYMMENE/HAINDL and NORSKE SKOG/ PARENCO/WALSUM (2001) 157 CHAPTER VI: PRACTICAL PROPOSALS Introductory Remarks Overview of Substantive Proposals as Developed in Chapter IV Procedural Proposals Conclusions and Outlook 175 Appendix 177 Endnotes 181 References 185 Index 191

11 PREFACE More than a decade after the European Union first introduced a common merger policy, this study evaluates the quality of that policy from a specific point of view, namely from the point of view of its predictability. It is argued that predictability is crucial for a welfare-enhancing merger policy and that European Merger Policy could be substantially improved on that score. European Merger Policy has already been subject to a number of reforms. A revised Merger Regulation came into effect in May 2004, which included a change in the substantive criterion to be used in order to assess whether a notified merger is compatible with the common market. Guidelines on horizontal mergers have also been introduced for the first time ever in European merger control. Additionally, after the Court of First Instance decided against the Commission in a number of widely publicized cases, a number of procedural changes have taken place within the European Commission s Directorate General for Competition such as the appointment of a chief economist and the requirement for proposed merger decisions to be subjected to peer review. Although it is too early to evaluate the quality of these recent reforms based on experience, all of them are critically evaluated on theoretical grounds in this study. But we do not stop there. We believe that the reforms did not go far enough and thus develop a number of substantial as well as procedural proposals for how European merger policy could be further improved. In a sense, we try to open the debate for yet another round of reforms. This study was sponsored by the European Round Table of Industrialists (ERT), a forum of some 45 leaders of major industrial companies whose headquarters are in Europe. ERT Members were concerned that the goals agreed upon by the European Council in Lisbon in March 2000 that aim at making the European Union the most competitive and dynamic knowledge-based economy in the world by 2010 called for EU competition policy to better reflect economic and market realities and to become more predictable and accountable. This led ERT Members to commission an academic study on the importance of predictability to successful competition policy. This study would not have been possible without the active support of the members of the ERT Competition Policy Working Group, chaired by Alain Joly. As economists from academia, we greatly benefited from the opportunity to discuss our hypotheses and preliminary results with the members of the ERT Working Group, all business-based competition specialists who have been involved in merger cases with the Commission. Our various discussions with the Head and members of the Commission s now defunct Merger Task Force proved equally useful. Special thanks to Claes Bengtsson who read the entire manuscript and made a number of critical remarks. Others who made very valuable comments include Ulrich Immenga, Manfred E. Streit, and Ingo Schmidt. Last but not least, two of our publisher s anonymous referees helped with additional suggestions. Stefan Voigt and André Schmidt Kassel and Göttingen, July 2004 xi

12 CHAPTER I PREDICTABILITY AS A CRUCIAL CONDITION FOR ECONOMIC GROWTH AND DEVELOPMENT 1. INTRODUCTORY REMARKS The title of this study puts the predictability of European Merger Policy at centre stage. This chapter serves to motivate and explain the outstanding importance attached to predictability. In the next section, the crucial importance of predictability for economic growth and development will be spelt out on an abstract and general level as well as with regard to competition policy and, more focused still, with regard to merger policy. Section three contains a brief summary of some of the empirical evidence dealing with the consequences of predictability or its absence. In section four, the current degree of predictability in European Merger Policy is operationalised. Predictability in European Merger Policy was also the issue of a survey conducted among large European firms. Their perception of predictability is reported there as well. Section five contains a number of institutional proposals whose implementation could help increase the predictability of European Merger Policy and hence its overall quality. 2. SOME THEORETICAL CONSIDERATIONS CONCERNING PREDICTABILITY Predictability can be defined as the capacity to make predictions concerning the actions of others that have a high chance of turning out to be correct. In economics, the term uncertainty is much more frequently used than the term predictability. The two terms are closely intertwined: the absence of predictability can also be described as the presence of uncertainty. As markets become increasingly turbulent, the predictability of the framework established and implemented by politics has become even more crucial. Merger policy can, however, also increase uncertainty if competition authorities are granted too much discretionary power and if they draw on various economic theories eclectically. It has been shown empirically that the stability of the framework within which companies act is decisive for economic growth and development. This includes, of course, the predictability of competition policy. A market economy is best described as a system of decentralised exchange often by millions of actors who are free to set their own goals. Ideally, exchange based on voluntarily entered-into contracts indicates that the parties involved expect to bebetter off as a result of the contract, otherwise they would not have consented to it in 1

13 2 CHAPTER I the first instance. But some contracts that make the participating parties better off might have welfare-reducing effects on other, third parties. From an economic point of view, the function of legislation in a market economy consists in (a) making welfare-enhancing exchange as easy as possible, and in (b) making welfare-reducing exchange as difficult as possible. Antitrust or competition rules two terms that will be used interchangeably play an important role with regard to these two functions. Since market economies are often made up of millions of autonomous decisionmakers, uncertainty is a constitutional condition of such systems. We cannot with any certainty predict the actions of millions of other actors. Uncertainty can, however, have detrimental effects on economic growth and development: it is connected with a short time-horizon, which reduces the propensity to invest as well as the readiness to specialise and to contribute to a welfare-enhancing division of labour. One function of legislation thus consists in reducing the degree of uncertainty. It has been argued (Kant 1797/1995, Hayek 1960, 1973) that the best way in which the state can contribute to the reduction of uncertainty consists in passing universalisable rules. These are rules that are (1) general, i.e., they apply to a multitude of cases in which a multitude of actors will be engaged, (2) abstract, i.e., they are formulated negatively and thus do not prescribe a certain behaviour but simply prohibit a finite number of actions, and (3) certain, i.e., interested individuals can know whether a certain action is within the legal domain or not. Universalisable rules do not eliminate uncertainty completely because they do not prescribe actors what to do. The dynamics of market economies depend on the possibility of individuals to act innovatively and innovations will by definition be unexpected by many. Universalisable legislation is a necessary but not a sufficient condition for a high degree of predictability. A high degree of predictability will only result if newly passed legislation will be implemented by an administration in a manner that allows interested individuals to anticipate the administration s decisions; if courts are involved, then the same applies, of course, to the courts adjudication. This was already recognised by James Madison (1788/1961), who wrote in the 37 th of the Federalist Papers: All new laws, though penned with the greatest technical skill and passed on the fullest and most mature deliberation, are considered as more or less obscure and equivocal, until their meaning be liquidated and ascertained by a series of particular discussions and adjudications. Formulated differently: A system of rules whose interpretation is perceived as unsystematic or erratic is almost as bad as not having a rule system in the first place; hence the particular importance of case law. Lack of predictability in competition policy can also be detrimental to the realisation of welfare gains. If market actors are uncertain as to what competition rules mean or how they will be interpreted by the competition authorities and/or the courts, a number of negative welfare effects can result: if market actors believe that a merger will not be cleared, mergers whose consummation would allow the realisation of efficiency gains, will not take place. This means that productive efficiency is lower than it could be were the merger carried out. On the other hand, if market actors believe that a proposed merger will be cleared, they might already invest in the entity to be created as the result of the merger. Prohibition of a merger can, then, be

14 PREDICTABILITY AS A CRUCIAL CONDITION 3 interpreted as a case of disappointed expectations, or: unpredictability of the competition policy as currently implemented. Decisions on single cases have effects that often go far beyond a single case: they are observed by a multitude of other actors and thus become precedent. Precedent that signals a tough stance on proposed mergers can also be a barrier to the realisation of welfare gains: potentially welfare-enhancing mergers might be discouraged by precedent right from the outset. As just pointed out, this will prevent the realisation of higher levels of productive efficiency. Predictability allows market participants to make predictions concerning the decisions of competition authorities that have a good chance of turning out to be correct. The existence of precedent as such is not sufficient to secure a high level of predictability. Rather, the criteria used by the competition authorities should be as clear-cut as possible. Additionally, the analytical tools used to translate criteria into operational data should be as transparent as possible. Legal certainty also has a time dimension. For entrepreneurial action in general and for mergers in particular, timing is often crucial. It is therefore not only important to get the right decision at all but to get it in time. In case the merging firms believe that a competition agency interpreted the relevant legislation falsely, the availability of legal remedies that are at their disposal within very short notice can thus be very important. Before inquiring to what degree these essentials of predictability are realised with European merger policy, let us have a quick look at some empirical evidence concerning the role of predictability. 3. SOME EMPIRICAL RESULTS CONCERNING PREDICTABILITY Let us now quickly turn to some empirical studies that can be interpreted as evidence for the crucial importance of predictability. As an example for the importance that should be attached to the issue of predictability with regard to the general functioning of market economies, we cite a cross-country study by Brunetti et al. (1997). Empirical research concerning the effects of merger policy is very rare. Most of the existing studies deal with the effects of US antitrust policy. We will refer to two of these studies, Shughart and Tollison (1991) and Bittlingmayer (2001). Empirical evidence concerning the economic consequences of European merger policy is virtually non-existing and definitely a desideratum. Over the last number of years, an entire cottage industry dealing with the economic effects of formal institutions as, e.g., constitutions and legislation has developed. Rather than providing an overview of that literature, we confine ourselves to the presentation of one such study here (a short survey can be found in chapter five of Voigt 2002). It has been selected because it does explicitly exclude the material content of rules and concentrates exclusively on the perceived credibility of rules. In a study commissioned by the World Bank, Brunetti, Kisunko, and Weder (1997) use what could be called subjective uncertainty indicators. They asked local entrepreneurs in some five dozen countries whether they believed the announcements of their governments to be credible. If the locals do not believe their government, then a government announcing secure private property rights, low tax

15 4 CHAPTER I rates, etc., will not induce investment. There is thus a very close relationship between credibility and predictability. Notice that neither concept focuses on the content of the rules but just on the formal issue of whether some policy (in the form of legislation or the like) announcement is believed to be implemented. Brunetti et al. (1997) surveyed more than 2,500 entrepreneurs in less developed countries and approximately 200 entrepreneurs in OECD member states. The partial indicators security of persons and property rights and predictability of legislation are most closely correlated with economic growth in this sample of 58 countries. The partial indicators corruption, perceived political instability and predictability of judicial decisions closely correlate with investment rates. Let us now turn to the empirical studies interested in the economic effects of antitrust policy. Shughart and Tollison (1991) are interested in ascertaining the employment effects of the Sherman and Clayton Acts, i.e., those two laws that are commonly believed to be the core of US antitrust policy. They conjecture that unanticipated strengthening of antitrust enforcement, i.e., low predictability of the actions of antitrust agencies, can force firms to adopt inefficient production technologies. As firms are forced to lower their current and planned production quantities, they might have to lay off some of their employees as a consequence. Suppose enforcement of antitrust legislation is unexpectedly strengthened in a particular industry. Mergers might be prevented and divestitures ordered. Suppose this is accompanied by unchanged production technology, which would mean that from a production oriented point-of-view, the optimal size of firms in the industry has remained unchanged. Yet, the optimal size of firms in that specific industry is reduced due to increased enforcement effort. Shughart and Tollison argue that this will lead firms to lower their current and planned production as well as to lay off some of their employees. If other industries with similar structures observe this, unemployment may also increase there. For the period between 1947 and 1981 (the starting point was chosen because 1947 is the first year for which extensive data concerning the U.S. labour market are available), they find a positive and significant relationship between unanticipated increases in antitrust enforcement activities and the unemployment rate. This study can thus be read as empirical evidence supporting the claim that the absence of predictability here called unanticipated increases in antitrust enforcement activities can have real economic costs, namely an unemployment rate that is higher than if merger policy was predictable. Bittlingmayer (2001) is interested in determinants of investment levels. In empirical studies seeking to identify the factors determining investment, only economic variables such as interest rates or the prices of capital goods have traditionally been taken into consideration. Bittlingmayer now argues that these regressions always leave a fair amount of variation in investment unexplained and suspects that political uncertainty could be one such factor. He is then in need of a proxy for political uncertainty and chooses antitrust enforcement as that proxy. Based on data for the period between 1947 and 1991, he comes to the conclusion (ibid., 321) that statistically, each extra case [of antitrust enforcement] is thus associated with a total decline in investment of about $1.7 billion. It is worth noting that the major adverse effects on investment do not arise within the industry of the firms against which a

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