Corporate Mergers and Antitrust

Chapter 25

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

25-2

Learning Objectives

After this chapter, you should be able to:1. Define and explain antitrust.

2. List and discuss major antitrust laws.

3. Discuss the origins and practice of modern antitrust.

4. Name and analyze types of mergers.

5. List and discuss the main industries that were deregulated since the late 1970s.

6. Discuss and assess corporate corruption.

7. Summarize the trend toward business.

8. Explain how pharmaceutical fraud is a type of corporate fraud.

25-3

A Historical Perspective on Corporate Concentration

The history of the American economy since the Civil War (1860–1865) has been one of growing corporate concentration.

• Like tides, this concentration has had its ebbs and flows.

During the last century and a quarter, a few hundred companies came to dominate our economy.

25-4

Antitrust: The Political Background

During the 19th century, the federal government rarely intervened in the economy.

But there were two major forms of intervention, both of which were key issues in the events leading up to the Civil War:

• High protective tariffs • The transcontinental railroad

25-5

Antitrust: The Political Background (continued)

High protective tariffs made imports more expensive and greatly aided Northern manufacturers.

• This forced the South to pay much higher prices for the foreign goods they needed.

The transcontinental railroad was built with tremendous amounts of federal aid and it completely bypassed the South.

Both policies were benevolent to big business, so few protests were raised about government intervention in the economy.

25-6

The Political Background

The late 19th century was the era of the “trust”.

Trusts were cartels that set prices and allocated sales among their member firms.

• The most blatant were in oil and sugar.• Others were in meat packing, cottonseed and linseed oil,

lead, leather, whiskey, tobacco, electrical tools, coal, steel, and the railroads.

Typical attitudes of the trust• The great financier J. P. Morgan proclaimed, “I owe the public

nothing.”• Railroad tycoon Billy Vanderbilt said, “The public be dammed,

I am working for my stockholders.”

25-7

The Sherman Antitrust Act (1890)

Congress left the language of the law rather vague.

Finally, after years of preparation by the [Teddy] Roosevelt and Taft administrations, suits were brought against Standard Oil and American Tobacco.

• These companies were broken up by the court, not because they were big but because they were bad.

25-8

The Rule of Reason

The Supreme Court’s decision breaking up Standard Oil and the American Tobacco Company was based on what they called its “rule of reason.”

• Bigness itself was not an offense as long as that bigness was not used against rival firms.

• This was in effect saying that the wolf not only had to be big and bad, but he actually had to blow the house down before he broke the law.

• So mere size is no offense.

25-9

The Clayton Antitrust Act (1914)

Prohibited 5 business practices that lessened competition or tended to create a monopoly when their effect was to “substantially lessen competition or tend to create a monopoly”:1. Price discrimination

2. Interlocking stockholding

3. Interlocking directorates

4. Tying contracts

5. Exclusive dealings

Also expressly excused labor unions from prosecution under the Sherman Act.

25-10

The Federal Trade Commission Act (1914)

The Federal Trade Commission (FTC) was set up as a watchdog agency against the anticompetitive practices outlawed by the Sherman and Clayton acts.

• The courts stripped most of its powers by the 1920s.• In 1938, the Wheeler-Lea Amendment gave the Federal Trade

Commission what has become its most important job: preventing false and deceptive advertising.

• In recent years, the FTC has been playing a more active role in approving or disapproving mergers before they are ever fully carried out.

Examples: Staples and Office Depot; Barnes & Noble and Ingram Book Group

25-11

Modern Antitrust

Antitrust enforcement evolved over the past century, growing more stringent or lax, depending on the presidential administration as well as the political leaning of the Supreme Court justices and the judges sitting in the lower federal courts.

In Europe, enforcement varies from country to country.• The formation of the 15-member European Union has resulted

in a more unified approach to antitrust, especially since 1997.

25-12

Partial Breakdown of the Rule of Reason The membership of the Supreme Court changed

radically during the Roosevelt and Truman administrations.

In a landmark 1945 decision, the Court found that the Aluminum Company of America (Alcoa) which held 90 percent of the aluminum market, was an illegal monopoly.

This decision eclipsed the “rule of reason.”• Alcoa lost because they were big, not because they were both

big and bad.

25-13

The 60 Percent Rule

What has apparently evolved from past antitrust decisions is what might be called the “60 percent rule.”

• “Should a firm have a share of at least 60 percent of the relevant market and should that firm have behaved badly toward its competitors, it would then be subject to prosecution.”

• Whether a firm would be prosecuted would depend on the

political and economic outlook of the current administration and the outlook of the Supreme Court justices.

25-14

Two Landmark Cases

1. AT&T

2. Microsoft

25-15

Two Landmark Cases: AT&T

AT&T was accused of having a monopoly on local phone service (which it could hardly contest) and of making it hard for long-distance competitors to use its local phone network.

AT&T was allowed to keep its long-distance service in exchange for giving up its 22 local phone companies.

AT&T was also allowed to enter the telecommunications-computer field.

25-16

Two Landmark Cases: Microsoft

Windows, Microsoft’s operating system, runs on more than 90% of all PCs.

This has enabled the company to eliminate competition and innovation—probably harming consumers.

In 1995 and 1997, the U.S. government took action

against some of Microsoft’s practices; an out-of-court settlement was reached in 2002.

25-17

European Antitrust

European Union (EU) antitrust is conducted by the European Commission, headquartered in Brussels.

In recent years, enforcement has moved away from technical legal requirements to examining the consequences on competition.

In 2004, the European Commission ruled that Microsoft had broken EU law using its monopoly power.

• EU Commission has no jurisdiction/power over mergers between U.S. firms, but they do have power to make it difficult to do business in the EU.

• Microsoft fines in Europe were over $2 billion; in 2008, Microsoft finally settled with the EU and agreed to comply with the Commission’s demand to share details of its Windows operating system with rivals.

25-18

Types of Mergers

Horizontal mergers

Vertical mergers

Conglomerate mergers

25-19

Horizontal Mergers

Horizontal merger: the conventional merger of two firms in the same industry.

• Usually a larger firm swallows a smaller one.

• The legal problem with horizontal mergers is that they appear to violate the Sherman Antitrust Act by lessening competition.

25-20

Vertical Mergers

Vertical merger: when firms that have been engaged in different parts of an industrial process or in manufacturing and selling join together.

Examples:• Walt Disney’s 1995 acquisition of ABC• AOL + Time Inc. + Warner Brothers • Columbia Pictures and Sony

25-21

Conglomerate Mergers Conglomerate merger: when two companies in

unrelated fields join together. Conglomerating has several advantages:

• It can provide ready-made markets for the goods and services produce by various divisions.

• The very diversity of the company is insurance against economic adversity.

• Certain tax advantages

Conglomerating sometimes does not work out well• The companies do not mesh and inefficiencies often result.

Best example today is General Electric: manufacturing, broadcasting (NBC), finance.

25-22

Deregulation

The federal government has had a very strong role in regulating corporate behavior.

It has been estimated that American businesses spend upwards of $100 billion annually just to follow all the federal rules and regulations and employ people to fill out all the required forms.

25-23

Corporate Misconduct

Corporate misconduct is not an antitrust issue, per se.

Since corporate officers cannot always be counted on to uphold the law, tighter government control is needed.

When stockholders are bilked and employee pension funds are wiped out, many Americans want the federal government to prevent such abuses from recurring.

Some abusers found guilty: Enron, WorldCom, Arthur Andersen, Xerox, Adelphia, Tyco, Incline, Qwest, HealthSouth, AIG, investment banks.

25-24

How Effective Is Antitrust? What do we want antitrust to do?

• If we want to create something approximating perfect competition, antitrust has failed miserably.

• If we would like to prevent further oligopolization of American industry, it has been a qualified success.

• Without antitrust things could have been a lot worse. There would have been no legal means to curb any mergers. Many firms hesitate to merge because they are fairly certain

the U.S. Justice Department would take legal action.

• The whole focus of antitrust policy has been on mergers and not on firms that generate their own growth.

25-25

The Trend Toward Bigness: The Largest U.S. Corporate Mergers and Acquisitions

25-26

The Largest Worldwide Corporate Mergers and Acquisitions

25-27

The Trend Toward Bigness

American business is steadily becoming more and more concentrated.

Mergers are part of a worldwide trend which shows no signs of slowing down.

The distinction between American and foreign companies is becoming blurred.

25-28

The Trend Toward Bigness (continued)

Multinational corporations are becoming more common.

Because markets are global, few companies are reaching the size and scale that should cause concern about monopolies (or should it?).

How does one nation, even the U.S., enforce its antitrust laws in the global market place?

25-29

Current Issue: Pharmaceutical Fraud

Fraud not just insider trading, misuse of company funds, stealing, inflated financial results or “cooked” accounting books.

Pfizer aggressively marketed drugs not approved by the FDA.

In 2009, Pfizer paid $2.3 billion to settle civil and criminal allegations it had illegally marketed a painkiller called Bextra; largest criminal fine of any kind.

Bextra was FDA-approved for arthritis and menstrual cramps, but not acute pain.

Bextra was withdrawn from the market for all uses in 2008 because of risks to the heart and skin.

Eli Lilly paid $1.4 billion fine in 2009 to settle charges over the antipsychotic drug, Zyprexa.