[Cross posted at Truthonthemarket]
I don’t think so.
Let’s start from the beginning. In my last post, I pointed out that simple economic theory generates some pretty clear predictions concerning the impact of a merger on rival stock prices. If a merger is results in a more efficient competitor, and more intense post-merger competition, rivals are made worse off while consumers benefit. On the other hand, if a merger is is likely to result in collusion or a unilateral price increase, the rivals firms are made better off while consumers suffer.
I pointed to this graph of Sprint and Clearwire stock prices increasing dramatically upon announcement of the merger to illustrate the point that it appears rivals are doing quite well:
The WSJ reports the increases at 5.9% and 11.5%, respectively. In reaction to the WSJ and other stories highlighting this market reaction to the DOJ complaint, I asked what I think is an important set of questions:
How many of the statements in the DOJ complaint, press release and analysis are consistent with this market reaction? If the post-merger market would be less competitive than the status quo, as the DOJ complaint hypothesizes, why would the market reward Sprint and Clearwire for an increased likelihood of facing greater competition in the future?
A few of our always excellent commenters argued that the analysis above was either incomplete or incorrect. My claim was that the dramatic increase in stock market prices of Sprint and Clearwire were more consistent with a procompetitive merger than the theories in the DOJ complaint.
Commenters raised three important points and I appreciate their thoughtful responses.
First, the procompetitive theory does not explain the change in all stock market prices. For example, readers pointed out that Verizon’s stock barely ticked downward, while smaller carriers MetroPCS and Leap both fell (.8% and 2.3%, respectively, according to the WSJ). The procompetitive theory, the commenters argued, implies that Verizon and these other rivals should move upward.
Second, they argue that perhaps an exclusionary theory of the merger better explains these stock price reactions. Indeed, the new 2010 Horizontal Merger Guidelines included (not without controversy) potential exclusionary effects (“Enhanced market power may also make it more likely that the merged entity can profitably and effectively engage in exclusionary conduct. “). Rick Brunell of AAI writes:
Although the smaller carriers may gain in the short run due from a merger that raises prices, they also may lose in the long run due to its exclusionary effects, a theory that was front and center of Sprint’s opposition (and the smaller carriers’). Notably Verizon, which has no reason to fear exclusion and would have the most to lose if the merger were actually efficient, has not opposed the merger.”
Similarly, Matt Bodie writes:
Why wouldn’t the market’s reaction be a sign of this: (a) the AT&T/T-Mobile merger will give the new entity strong market power, (b) there are strong anticompetitive as well as efficiency gains from being bigger and having more market size, (c) the newly merged company would use that power to crush its weakest competitors, i.e. Sprint? After all, isn’t there a traditional story where monopolists cut prices to drive other competitors out, but then gradually raise price once their market power allows it, especially in industries with high barriers to entry?”
The basics of the exclusionary theory of the merger is that the anticompetitive harm is not coordination or unilateral price increases from the direct acquisition of market power, i.e. the elimination of competition from a close rival. Rather, the exclusionary theory posits that the post-merger firm will have sufficient market power to exclude rivals from access to a critical input (e.g. backhaul) and, as Matt has it, “crush its weakest competitors.” So to Matt, yes, there is that theory in antitrust. But note that the post-merger share of the combined entity here would be nowhere close to traditional monopoly power standards required to make out a monopolization claim under Section 2 of the Sherman Act. The new Guidelines do quasi-endorse the possibility of a Minority-Report like merger enforcement search for exclusion that doesn’t reach Section 2 standards post-merger, but might someday, but also needs to be stopped now. But it is decidedly not standard in merger analysis. And this case is probably not a good test case for that theory; at least the DOJ thinks so. But no, I don’t think the market reaction is reflecting concerns about exclusion. More on that in a second. But for now note that this is not simply a legal point. While the law requires the demonstration of monopoly power for a Section 2 claim, the economic literature focusing upon exclusion also considers market power a necessary but not sufficient condition for competitive harm. For the same reasons the exclusion claim would be rejected post-merger on legal grounds if we accept the market definition alleged by the DOJ, exclusion is unlikely as a matter of economics.
Put simply, the exclusionary theory’s proponents argue that it can explain the increase in Sprint’s stock price (reduced likelihood of future exclusion because of the DOJ challenge) and Verizon’s inconsequential reaction (it has “no reason to fear exclusion”).
Just so everybody is seeing the same thing — here is a chart with 5 days of trading including Verizon, Sprint, Clearwire, MetroPCS, Leap and the S&P 500.
Third, commenters argue that this simple analysis doesn’t account for other important factors. NB writes:
Why did you choose Sprint particularly? Verizon, a larger and far more significant competitor, had its stock drop sharply in that same period you show Sprint “surging”. MetroPCS’s stock also dropped.So what does it mean when a weak competitor’s stock jumps but two other competitors who are doing well have their stock drop? Other than that there are clearly more factors in play here?
Enough questions; time for answers.
Why Didn’t I Include the Exclusionary Theory of Harm?
I plead guilty. Or at least guilty with an explanation. I didn’t discuss the possibility of exclusion and whether it would better explain these market reactions than the theory that the merger is efficient or anticompetitive because it will facilitate coordination or unilateral price increases. As it turns out, however, the reason is that the post was motivated by the following question:
How many of the statements in the DOJ complaint, press release and analysis are consistent with this market reaction?
Turns out, I’m in pretty good company in omitting this theory. The DOJ didn’t allege it either. As discussed above, the DOJ specifically alleged that the merger would result in coordinated effects in the national market and/or unilateral price increases. Rick Brunell accurately points out that Sprint and AAI have both made these arguments. Indeed, when I testified in the House on the merger, there were a lot of questions raised about exclusionary concerns. But the bottom line is that they are not in the Complaint. Apparently, those arguments did not persuade the Justice Department. I have no intention on running from the interesting question posed by the commenters that the exclusion theory does a better job of explaining market price reactions. That’s next. But for now, let me say that I think there is a good reason the DOJ did not accept the Sprint / AAI invitation to adopt the exclusion theory.
Does Exclusion Do A Better Job of Explaining Verizon’s Non-Movement or Slight Fall?
I think proponents of the exclusion theory of the merger have a tough task here. Notice that the prediction of the exclusionary theory is NOT that Verizon’s stock price will stay put or fall. Instead, it is that it will increase post-merger. While Brunell observes that Verizon need not fear post-merger exclusion itself, it would certainly be happy to free-ride on the allegedly imminent exclusionary efforts of the newly merged firm. Post-Chicagoans often invoke the argument that “competition is a public good” when explaining why a downstream input provider has reason to go along with an upstream firm’s attempt to monopolize. Bork argued that the downstream firm had no reason to engage in a contract with the upstream provider that would increase the likelihood that he would be facing an upstream monopolist (and thus worse terms of trade) tomorrow. The classic Post-Chicago response is that each downstream firm doesn’t take into account the impact of his private decision to enter into such a contract with the would-be monopolist — that is, competition is a public good. The flip side of this argument is that exclusion is a public good too! To put it more concretely, if the post-merger combination of AT&T / T-Mobile were able to successfully exclude Sprint and smaller carriers such as MetroPCS and Leap, and thereby reduce competition, the clear implication of this theory is that Verizon would benefit.
The relevant economics here are not limited to the possibility that post-merger AT&T would successfully exclude Verizon. Think about it: both Verizon and the post-merger firm would benefit from the exclusionary efforts and reduced competition. However, Verizon would stand to gain even more! After all, it isn’t paying the $39 billion purchase price for the acquisition (or any of the other costs of implementing an expensive exclusion campaign). Thus, an announcement to block the would-be exclusionary merger — the one that would allow Verizon to outsource the exclusion of its rivals to AT&T on the cheap — wouldn’t happen. Verizon stock should fall relative to the market in response to this lost opportunity. The unilateral and coordinated effects theories in the DOJ complaint are at significant tension with the stock market reactions of firms like Sprint (and its affiliated venture, Clearwire). The exclusion theory predicts a large decrease in stock price for Verizon with the announcement. None of these comfortably fit the facts. Verizon more or less tracks the S&P with a slight drop. What about the smaller carriers? Take a look at the chart. MetroPCS barely moved relative to the market (in fact, may have increased relative to the market over the relevant time period); Leap is down a bit more than the market. Here, with the smaller carriers there is not a lot of movement in any direction. But, contra NB’s comment (“Verizon, a larger and far more significant competitor, had its stock drop sharply in that same period you show Sprint “surging”. MetroPCS’s stock also dropped.”), Verizon’s small fall relative to the market is nowhere near the magnitude of the positive effect on Sprint and Clearwire.
But what about competition? Isn’t it true that if the merger was procompetitive a challenge announcement would likely mean less competition for Verizon and also predict an increase in stock price? AAI’s comment tries to have this both ways. If Verizon’s price stays still, its because it has nothing to fear from exclusion (contra the economics above); if it goes down, the DOJ announcement has decreased the likelihood of those coordinated effects Sprint and AAI argued were so likely (but then there is Sprint’s big jump); and if Verizon prices increase then it just means that we weren’t right in the first instance than they were safe from exclusion. One is reminded of Tom Smith and his incredible bread machine. But this leads to an interesting point. Brunell and AAI (and perhaps other proponents of the DOJ challenge), as pointed out in the comments, appear to agree with me that stock market reactions are probative evidence of competitive effects. Perhaps they believe that the exclusionary theory is a better explanation of the facts — I obviously don’t think so. But we are where we are. That theory is not alleged. Now that we’ve observed the quite significant stock market reaction of Sprint to the challenge announcement. Do we at least agree those facts are in tension with the coordinated effects theory made so prominent in the DOJ complaint?
Couldn’t There Be Other Important Factors Explaining Stock Price Movements Unrelated to the Competitive Implications of the DOJ’s Challenge?
To write the question is to answer it. You bet there could be. And indeed, I wrote in the first post that while the fairly dramatic stock price reactions of Sprint and Clearwire were probative, the post was not a full-blown event study that would account for those events, formulate a market model, and test for the abnormal returns surrounding the announcement controlling for other important events. Further, not all competitors are created equal. Under the efficiency story, the distribution of benefits will accrue proportionately to the rivals who were most likely to face increased competition post-merger (and now are more likely not to). I certainly agree with Rick Brunell’s summary comment that the stock price evidence is somewhat “mixed.” There are small and relatively ambiguous effects — once one includes the market performance — on the stock prices of Metro and Verizon. Leap is more clearly down, even if by a small amount relative to the market. There may well be a variety of factors unrelated to the announcement confounding effects here. This is the reason we do real event studies in practice and why I do not believe the simple collection of evidence here warrants sweeping conclusions about the merits of the merger.
However, the DOJ complaint tells us that the important competitive players in the market — the “Big Four” — are AT&T, T-Mobile, Sprint, and Verizon. Focusing upon the non-merging big 4, we see Sprint’s price going up dramatically and Verizon’s staying put. The former is simply more consistent with procompetitive theories than the coordinated effects and unilateral effects theories alleged in the DOJ complaint. One might expect an announcement to block a procompetitive merger to have a greater positive impact on Verizon stock. But, as many have observed in the press, the impact of the merger upon Verizon is complicated by a number of factors, not the least of which is that the challenge announcement increases the likelihood that the DOJ is committed to challenging any future attempts to merger by Verizon. Unless spectrum capacity is increased dramatically (see this excellent Adam Thierer post on this score) in the very near future it is difficult to see how the reduced ability to exercise that significant and valuable option would not also impact Verizon. Thus, while not a slam dunk by any means, the procompetitive theory of the merger does a pretty decent job on the Big Four. It certainly beats the coordination theory trumpeted in the Complaint. As for the attempt of AAI and Sprint to salvage the DOJ complaint with the exclusionary theory — perhaps it is not too late to amend, but it isn’t there now and I’d warn the DOJ against including it. With respect to the DOJ’s Big Four, the exclusionary theory is not only new and relatively controversial in the Guidelines, but also makes a strong prediction concerning a Verizon stock price increase that is inconsistent with the data.
There will certainly be more data as we move along. And it should interesting to watch how things unfold both in the market and between the DOJ and FCC as well. For now, however, color me unconvinced by the heavy reliance upon the structural, “Big 4 collusion” story leading the Complaint and the attempts to save it with exclusionary theories.