Lecture: Mergers. Some facts about mergers from Andrade, Mitchell, and Stafford (2001) Often occur in waves, concentrated by industry

Transcription

1 Lecture: Mergers Some facts about mergers from Andrade, Mitchell, and Stafford (2001) Often occur in waves, concentrated by industry Have been connected in the data to industry shocks (technological, demand, regulation) Robust patterns about stock market returns overall and by target and acquiring firm Earlier work, Ravenscraft and Scherer found poor post merger performance, recent work comparing performance to unmerged firms in the same industry has merged firms looking better.

2 Let s look at some tables.

3 Tables and Figures from Andrade, Mitchell, Stafford (2001)

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7 Literatures on Mergers Finance where most of the recent research is Theory: E.g., Eat or Be Eaten: A Theory of Mergers and Firm size, Gorton, Kahl, and Rosen, in Journal of Finance (2009) Empirical: E.g., Maksomovic, Phillips, Prabhala (2009) on Post-Merger Restructing and Boundaries of the Firm, Jovanovic and Roussau have a few papers in macro/io literature, explaining waves from technological cahnge, Mergers as Reallocation, Restat IO literature an antitrust

8 estimate demand and simulate impact of merger for antitrust purposes a few papers (not many!) look at impacts of merger.

9 Antitrust Analysis of Mergers Take antitrust policy. mergers Suppose have a criteria for permitting Example 1: allow if prices fall (consumer surplus increase) Example 2: allow if total surplus increases What kind of guidanace can we give the office? Williamson tradeoff. Whinston handbook chapter What does the selection that firms want to merge tell us?

10 Farrell and Shapiro (from Whinston handbook) Take a static homogenous products -firm Cournot oligopoly, where firm cost functions may differ. Firms 1 and 2 contemplate a merger. Assume w.l.o.g. that 1 2 in premerger case. Premerger FONC ( is premerger output) 0 ( ) 1 + ( ) 0 1 ( 1) = 0 0 ( ) + ( ) 0 2 ( 2) = 0 which implies 0 ( )( )+2 ( ) 0 1 ( 1) 0 2 ( 2)=0

11 (Note 1 2 implies 0 1 ( 1) 0 2 ( 2) Assume merged firm s profit is concave in output. Optimal output (given rival s premerger output) is greater than the sum of the two firms premerger output iff or 0 ( )( )+ ( ) 0 ( ) ( 2) 0 ( ) ( ) 0 1 ( 1) which can happen only if (since 1 2 ) 0 ( ) 0 1 ( 1). Stringent requirement, reallocation not enough. To see why, let ³ ( ) = min 1 ( )+ 2( 0 ) 2, such that = 2

12 and suppose If 0 1 ( 1) 0 2 ( 2) then 0 1 ( 1) ( ) 0 2 ( 2)

13 So maybe price goes up. increase anyway? But any tips for when welfare might Sufficent to show sum of welfare of non-participants and consumers goes up. = Z ( ) ( ) + X [ ( ) ( )] So what happens if the merger decreases output a little, 0? Then = + X 0

14 Effect on is h ( ) 0 ( ) i 0 ( ) + X 0 ( ) + X h 0 ( ) i = 0 ( ) + X = 0 ( ) = 0 ( ) + X µ + X µ so 0iff X µ

15 So = = 1+ P Special case: Linear demand, constant marginal cost. ( ) : ( ) =0 = +1 = 1 +1

16 substitute into the above So condition is: = 1+ P = = = 1 X But note here that unless cost decreases for the merger, two firmswithlessthanhalfthemarketsharewouldnot want to merge (Salant Switzer, Reynolds). See in exam-

17 ple: Now Cournot quantity : = +1 Cournot Profit : ( ) =( ) µ (1) 2 (2) ( ) 2 ( +1), 2 µ Suppose costs are ( ) = 1 2 2, so merger means something more than moves in a Cournot game. Suppose ( ) = as above. Then external effect is positive if = µ 1 X 2

18 where is the elasticity of demand calculated at premerger price. Cute result because it has a Hirfindahl index in it.

19 Nocke and Whinston: Add Multiple Possible Mergers Dynamic Merger Review (another cute result) Homogeneous goods, constant marginal cost Cournot Industry ( )= (so allow cost asymmetry) Assumption 1: For any 0 such that ( ) 0, 0 ( ) 0 0 ( )+ 00 ( ) 0 lim ( ) =0 lim 0 ( ) min

20 Reaction functions solve: ( + ) + 0 ( + )=0 Asumption 1 implies (when interior) 1 ( ) 0

21 Consumer Surplus Effect of Mergers ( ) = Z 0 [ ( ) ( )] CS increases iff output increases Merger is CS neutral if does not affect CS (increasing or decreasing) Lemma 1: If a merger among active firms is CS-neutral then 1. It causes no changes in the output of any nonmerging firm nor the total output of merging firms.

22 2. the merging firm s margin at the pre-merger price ( )equals the sum of their premerger margins ( ) = X [ ( ) ] (show proof on board by summing the FONC) 3. the merger reduces the merging firm s marginal cost below the marginal cost of the most efficient merger partner min { } 4. The merger is profitable. Corollary 1: AmergeramongactivefirmsisCS-neutralif =ˆ ( ) ( ) X [ ( ) ]

23 and CS-increasing if ˆ ( ) and CS-decreasing if ˆ ( ). Or, if there are firms in, = X ( 1) ( ) Look at some graphs

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27 Proposition 1: The sign of the CS-effect of two disjoint mergers is complementary Proposition 2: Suppose that the merger 1 is CS-nondecreasing in isolate, while merger 2 is CS decreasign in isolation, but CSnondecreasing wonce merger 1 has taken place. Then (i) merger 1 is CS-increasing (and therefore strictly profitable) conditional on merger 2 taking place; (ii) the joint profit ofthefirmsinvolvedinmerger 1 is strictly larger if both mergers take place than if neither merger takes place. Doalittlemorework:EconometricApproaches Estimate a demand curve, e.g.

28 or BLP type ln( )= ln( )+ 2 ln( )+ 3 ln( )+ = + + Estimate costs. Directly, or nowaways, indirectly (take demand and back out cost from) 0 ( ( )) ( ) + ( ) =0 Pins down 0 ( ( )). Now simulate the effect of the merger.

29 Dynamics of Mergers Gowrisankaran and Holmes Suppose we don t have antitrust. Do markets go to monopoly if no scale economies? Without merger they don t (your homework) Butwhatiffirms can buy up other firms? may seem like this is an easy yes but actually, there are important forces going the other way.

30 Discrete time, discount factor Demand curve = ( ) constant over time. (Partial equilibrium model of industry).

31 Technology Inputs: industry-specific capital and labor Outputs: current output and next period industry-specific capital Fixed proportions, (1 ) units next-period capital per unit of current output. Constant returns to scale Industry-specific capital is necessary ( ) is labor cost to produce units of output with one unit of capital,increasing and convex

32 List of players Fringe sector. Firms behave competitively Dominant firm behaves strategically.

33 Sequence of Moves Initial state at pre-merger stage : capital of dominant firm : capital of fringe = + = pre-merger dominant firm share

34 Stage 1: Merger Phase Dominant firm picks point on fringe supply of capital. Results in: capital price post-merger share net trade in capital Stage 2: Output/Investment Phase Dominant firm picks point on residual demand curve in output market, then fringe make investment decision. (Stackelberg) dominant firm output level per unit of capital

35 fringe output level Results in: =, =(1 ) = + 0 = (1 ) 0 =

36 Equilibrium Markov-perfect equilibrium Capital stocks are payoff-relevant states,, and ( ) fringe value (one unit of capital) at investment/output stage ( )dominantfirm (per unit of capital), at investment/output stage total return is ( ) = ( )

37 ( ) total return to dominant firm at merger stage. Price of capital is ( ). ( )=max ( ) ( ) ( ) (1) ( ) is merger policy function. ( ) fringe value at merger phase. ( )= ( ( ) ). (2)

38 Investment stage equilibrium conditions Fringe ( ) = argmax ( )+ 0 (3) where : and 0 are fixed and are determined by = ( ) (4) = +(1 ) ( ) 0 = ( 0 0 ) 0 = +(1 ) ( ) 0 = (1 )

39 Dominant firm ( ) = max ( ) ( )+ ( 0 ( ) 0 ( )) (5) subject to : = ( ( )) ( ) = +(1 ) ( ) 0 ( ) = +(1 ) ( ) 0 ( ) = (1 ) ( ).

40 Rest of paper looks what happens in between. Answer depends on: Elasticity of demand Elasticity of supply

41 Single Period Model Normalize = 1 and leave it implicit (so write ( ) and ( )) Are perfect competition and monopoly absorbing states? Prop 1: Equilibrium merger policy function satisfied (1) = 1 and (0) = 0. Proof. (i) If = 1, merger problem is: n max ( )+(1 ) ( ) o. (6)

42 (ii) If = 0, merger problem is: max n ( ) ( ) o. (7)

43 Are there mergers or selloffs?investment stage in the =0 case Look at investment stage: max ( ) : 0 ( )=0

44 Dominant Firm max ( ) ( ) : 0 ( )=0 : = + " +(1 ) # For 0,. Look at picture Lemma 2: Marginal value of capital transfer greater from dom. firm then for fringe:

45 [ ( )] = ( )+ ( ) Z ³ 0 ( ) Look at picture Proposition 2. Assume: (i) = 0, (ii) (0 1) (iii) Regularity Condition. Then, the optimal capital purchase is strictly positive.

46 Is there merger to monopoly? Yes if initial share is high enough What happens if no merger to monopoly?

47 Multi-Period Model Are perfect competition and monopoly absorbing states? Yes Are there mergers or sell-offs? Proposition 5. (i) Assume demand is elastic, and suppose there is a finite horizon,. Fix an initial capital stock 1.If 1 1 is close enough to one, then 1 ( 1 1) 1 ;i.e.,thereisa positive merger. (ii) Suppose the horizon is infinite, =. There exists a 0 1 such that if 0, = ( ) andthedominant firm s initial market share is positive but sufficiently small, then ( ) ; i.e., the dominant firm sells capital.

48 Constant Elasticity Case ( ) = (8) ( ) = Evolution of industry depends upon: Parameters:,, Initial share 0. Pictures