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European competition policy - merger policy Introduction As the chief enforcer of EU competition policy, the European Commission has the power to make or break some of the word's biggest companies. So how does the EU evaluate the economic factors behind approving or rejecting a merger within the EU? Consider a situation where the European Union Competition Commission is asked to investigate the grounds for approving or blocking a merger between two European businesses Examples to think about might include • Two low cost airlines seeking a merger • A takeover of one large pharmaceutical manufacturer with another MAIN ECONOMIC ARGUMENTS FOR APPROVING A MERGER Static efficiency - Mergers result in economies of scale and therefore improved productive efficiency (cost savings) Dynamic efficiency - Increased profits can be used for R&D into new products and new production processes (innovation) creating long term dynamic efficiency; provides funds for capital investment Role of the capital markets The capital markets will sort out mergers which eventually fail to deliver the promised benefits. If unsuccessful mergers occur, corporate raiders are always ready to kick out the unsuccessful management who are not making enough profit for shareholders (consequently the share price will fall). Survival of the fittest ensures efficiency by keeping management on their toes (thereby reducing X-inefficiencies) It is argued that this is a more effective mechanism than government intervention which will only make matters worse because of the potential for government failure. Market Contestability arguments Growth of interest in the concept of contestable markets complements the free market approach to mergers. By concentrating on removing entry barriers to a marker, monopolies and mergers can only remain dominant by producing good products efficiently. Investment argument Lower costs and a bigger combined business may prompt higher levels of capital investment which is good news for the productive capacity of the EU economy Globalisation argument Mergers and takeovers can reinforce and improve the competitive position of EU companies relative to non EU companies (a countervailing power to dominance of giant US firms) – important in industries that are becoming truly globalised and where increasing returns to scale / falling LRAC is an important ingredient of competitive advantage Enhancing economic integration within the EU Mergers and takeovers are an inevitable consequence of the creation of a single market – perhaps the EU competition authorities should take a benign view of mergers if they have at their core, the aim of creating a business large enough to provide goods and services to a community of over 370 million people (soon to be close to 500 million in the wake of EU enlargement) MAIN ECONOMIC ARGUMENTS FOR REJECTING A MERGER Mergers and takeovers create monopolies and market dominance; consumers are exploited and resources misallocated if there are significant entry barriers inhibiting competition – leading to market failure and a deadweight loss of economic welfare. Mergers can deter actual and potential competition. In practice, there are always barriers to market contestability especially in industries where set up (fixed / overhead) costs and sunk costs are high The evidence is mixed as to whether mergers improve companies' performance, either in terms of profitability, or cost savings – many of the claims for increased efficiency and economies of scale made prior to a merger prove to be exaggerated over time Imperfections in the capital markets: The market for corporate control is does not work optimally. Unsuccessful managements may remain in place for sometime. Shares are mainly held by financial institutions but whilst they are the owners they do not run the companies on a day to day basis. This means there is a divorce of ownership and control with managers pursuing their own interests (salary and welfare) rather than maximising profits for the shareholders. Employment effects – mergers and takeovers nearly always lead to rationalisation as part of a process of cost cutting (more productively efficient) but this may be at the expense of jobs (possibility of structural unemployment) and fewer outlets / choice for consumers (an issue of equity) WHAT ACTUALLY HAPPENS The vast majority of cases referred to the EU competition authorities are cleared. Less than 20 have been blocked over the last twelve years. In July 2001 the European Commission has blocked the $45bn deal between US firms General Electric (GE) and Honeywell. Although US competition authorities had given their approval to the deal, the commission was worried that the integration of Honeywell's avionics and GE's strength in jet engines could lead to dominance of the market. The EU also blocked a proposed merger between Air Tours and First Choice Travel: “The proposed operation would create a dominant position in the market for short-haul foreign package holidays in the United Kingdom, as a result of which competition would be significantly impeded in the common market” http://europa.eu.int/comm/competition/mergers/cases/#by_decision_type Main criteria for evaluating the impact of a merger • The market position of the merged firm (market share and other competitive advantages) • Strength of the remaining competitors • Customers’ buying power • Potential competition (is the market contestable?) Most mergers and takeovers take place in technologically dynamic industries – this has important implications for competition policy. Will a merger act to enhance or slow down the pace of innovation and levels of investment. Each investigation has to be considered on a case by case basis. |