Death by misadventure: merger control as an inefficient barrier to exit in investment-intensive markets
Abstrakt
European merger control principally focuses on the short run price effects of consolidation. When sunk costs are significant, markets that experience an unexpected drop in demand tend to produce unsustainably low prices and financial losses for all firms.
This creates pressure for consolidation - either by exit or by merger. Yet even when losses are large - in the sense firms cannot generate a positive return on capital - long lived assets can remain trapped in the market for as long as they continue to be cashflow positive.
If the operating costs of the assets are low, they may never become cashflow negative no matter how low prices fall. In these circumstances, merger becomes the only means by which to achieve the consolidation necessary to return prices to their long run sustainable level.
But merger control rules are in place precisely to block consolidation that would produce such short run price rises. Despite the presence of economic losses, the classic 'failing firm' defence is not available because it requires a loss making firm to show that their assets will exit the market completely.
And that might not be realistic prospect in the short or even medium term. This paper develops a model to demonstrate that in these circumstances - particularly when demand shocks persist over time - current merger control rules represent an inefficient barrier to exit.
The impact is that two few firms enter the market in the first place because they know that merger control rules will block their only way out in a downturn. The resulting lack of entry leads to more limited competition and inefficiently high prices when demand is strong.
Optimal merger control in high investment markets therefore involves a more lenient approach to the failing firm defence - allowing firms to consolidate when demand is weak and where a loss-making firm can sell out to a rival rather than be forced into a long a painful death by misadventure.