Inefficient Offers to an Agency Subject to Judicial Review: an econometric test of remedy agreement in EC merger regulation

Luke Garrod

Bruce Lyons

Andrei Medvedev

Bargaining theory suggests mutually beneficial early agreement

If both parties are rational and have complete information, mutually beneficial agreement will…

Definitely be reached andBe reached immediately

Incomplete information can explain some delay…Screening for other’s typeSignalling of own type

Evidence from…Experiments Labour bargaining

EC remedy agreements involve…Bargaining strategy from firmsMore passive competition agency

Merger remedies are agreements over the line between good and harmful parts of a merger

ECMR allows merger unless it impedes competitionFirms self-select mergers to avoid proposals that would certainly

fail this testNearly all merger proposals either cannot be shown to impede

competition or can be modified to this effect

Agency (DG Competition) has power to either Prohibit merger orAccept an offer to remedy harmful parts of merger (e.g.

divestment)Cannot make counter-offers

The institutions of EC remedy agreement provide a natural experiment to test theory of strategic offers

Two partiesCompetition agency and merging firms

Discrete ‘rounds’ (2-phase investigation)More information gathered in second roundAllows early or late agreement (or no agreement)

Legally specified… Time limits to each phase (i.e. limited evidence gathering)Order of who can make offers and who can accept/reject

Administrative system with judicial reviewAgency decision must be based on evidence

No signalling in offers – would not stand up to JRStrategic behaviour only on one side

Isolates strategy of firms – agency more passive

29% of remedies accepted only after delay

7% qualifying mergers are remediedAs opposed to either no competition problem (89%) or

withdrawn during proceedings (3%) or complete prohibition (0.6%)

Given remedies are agreed (in either Phase I or Phase II)……Probability of Phase I = 71% (1998-07)

1998 ECMR revision formalised Phase I remedies; modest upward trend in early agreement

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Ph.I/(Ph.I+Ph.II) remedies

The EC procedure lends itself to simple modelling: assumptions

Timing of movesPhase I remedy offer αO (firms) accept or Phase II (agency)

Phase II remedy offer αOO (firms) accept or prohibit (agency)

Representation of remedies where higher αT means more of merger is OK

Information Common knowledge of variance of agency’s evidence:

uniform with range 2σ ; but only firms know αT

Agency More evidence in Phase II: σ2 < σ1

Evidence supports agency estimates:

JR-robust decision rule: accept Phase I offer iff: αO < α1 (or αOO < α2)

Objective of merging firms

1,0T

KMax OOOOOO

IIPh.inApp.Pr*Ph.IinApp.Pr1IPh.inApp.Pr,

111 , TT

Phase I approval probabilities and expected decision errors are directly related

Probability of approval

If offer accepted in Phase IType 1 error (too much remedy) if αO < αT Type 2 error (too little remedy) if αO > αT

1

21 1PrPr

TO

OIPhaseinApproval

Optimal offers and consequent probability of delayed agreement are determined by same factors

Offers depend on whether firms find it optimal to make ‘for sure’ acceptable offer or risk disagreement

3 ranges depending on whether play completely safe in both phases, or only in Phase I, or to risk Phase II prohibition

Example of intermediate case:Optimal offer and Type of error if agreement in Phase I

Probability of failure to agree in Phase I

Same factors determine: (1) optimal offers; (2) type of error in Ph.I approvals; and (3) probability of failure to agree in Ph.I

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1* 1

KT

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1* 3Pr1

K

Empirical predictions from the model

Delay to Phase II more likely ifComplex or imprecise merger appraisal (high σ1)

High number of markets raising concernInexperienced agency (few previous cases)Vertical issues, coordinated effects, entry barriers, …?

Delay is relatively less costly to the firms (K/π)Large proportion of markets raising concern

Model does not predict any effect ofObvious harm of the merger (αT)

Combined market shares; rival sharesPolitical impact

Merger size per seNationality of merging parties

Data

SampleEU remedied mergers 1999-2006

N = 133i.e. all remedied mergers except 27 due to lack of reported data or predominantly vertical

Unit = mergerAggregated from many markets per merger

Mean 13; max 142Variables expressed as:

Market count (e.g. 13 markets under review)Share of markets (e.g. 52% markets created ‘concern’)Average across markets (e.g. mean combined market share = 64%)

Treatment of potential reporting bias

Different style of reports in Phase I and IIReporting of barriers to entry more likely in Phase IISelection of markets for which market shares are reported seems

higher in Phase I

To derive a consistent figure for markets under review, we applied a market share filter

Only count markets for which combined market share >25%

Consistent with EC ‘checklist’ filter

Applying filter drops more Ph.I than Ph.II markets

25% supported by sensitivity analysis

The filter removes more markets in Phase I, thus supporting our worry of reporting bias

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Merged Entity's Market Share Filter (%)

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of M

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Phase I

Phase II

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0.333

The market share filter mainly removes markets without concern

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Merged Entity's Market Share Filter (%)

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of M

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Markets with concern

Markets without concern

As predicted, Phase II mergers are more complex and have higher share of controversial markets

Variable Phase I Phase II

Markets 12.7 16.8

Mkts with concern 6.1 (53%) 10.5 (72%)

High barriers 2½ (25%) 8 (45%)

Vertical concern 12% mergers 28% mergers

Also as predicted, only negligible differences relating to size and mkt share

Variable Phase I Phase II

Combined revenue €40b €38b

Combined mkt share 59% 63%

Share of leading rival & concern

21% 16%

Share lead rival & no concern

25% 27%

Probit regression results to look out for

Delay if…

Complexity of appraisal by agency

many markets to appraise

Lower opportunity cost of delay for forms

high proportion of merger under scrutiny

dependent variable: Phase II = 1

(1) (2)

coefficient(standard error)

marginal effects

coefficient(standard error)

marginal effects

constant -0.8527 -1.0628

(0.5391) (0.6900)

number of markets (non-coordinated) 0.0148** 0.0046 0.0145** 0.0045

(0.0070) (0.0069)

number of markets (coordinated) -0.0986 -0.0307 -0.0979 -0.0305

(0.0713) (0.0716)

coordinated effects† 0.8801 0.3166 0.9331 0.3365

(0.6208) (0.6329)

merger number -0.0002* -0.0001 -0.0003* -0.0001

(0.0001) (0.0002)

% markets with concern 1.4407*** 0.4484 1.4180*** 0.4412

(0.4333) (0.4354)

US only† 0.0789 0.0251 0.0533 0.0168

(0.4624) (0.4658)

EEA and US† -0.7222* -0.1828 -0.7001* -0.1783

(0.3999) (0.4025)

merged entity’s mean market share - - 0.0039 0.0012

(0.0080)

R-squared 0.1636 0.651

Market Share Threshold 0% 20% 30%

Dependent variable: phase II (1) (2) (1) (2) (1) (2)

constant -0.7230 -0.9704 0.8127 -1.0708 -0.7306 -1.2481*

(0.5013) (0.6654) (0.5226) (0.6808) (0.5763) (0.7582)

number of markets (non-coordinated) 0.0092* 0.0093* 0.0122* 0.0122* 0.0171** 0.0164**

(0.0054) (0.0537) (0.0063) (0.0063) (0.0079) (0.0078)

number of markets (coordinated) -0.0891 -0.0878 -0.0860 -0.0852 -0.1154 -0.1186

(0.0590) (0.0592) (0.0656) (0.0658) (0.0897) (0.0920)

coordinated effects 0.9633 1.0249 0.7653 0.8331 0.8795 1.0061

(0.6537) (0.6665) (0.6091) (0.6226) (0.6013) (0.6216)

merger number -0.0003* -0.0003* -0.0003* -0.0002* -0.0002 -0.0002*

(0.0002) (0.0002) (0.0001) (0.0001) (0.0001) (0.0001)

% markets with concern 1.5903*** 1.5681*** 1.5057*** 1.4837*** 1.0795*** 1.1167**

(0.4084) (0.4102) (0.4290) (0.4307) (0.4484) (0.4518)

US only 0.1106 0.0752 0.1037 0.0705 0.0756 0.0356

(0.4651) (0.4699) (0.4634) (0.4674) (0.4529) (0.4575)

EEA and US -0.6839* -0.6627* -0.7226* -0.6985* -0.7129* -0.6657*

(0.3970) (0.3991) (0.3973) (0.3997) (0.3914) (0.3950)

merged entity’s mean market share - 0.0045 - 0.0047 - 0.0083

(0.0080) (0.0079) (0.0079)

R-squared 0.1853 0.1873 0.1669 0.1691 0.1327 0.1396

Conclusions

Delay in reaching agreement arises when competition issues are complex and delay is costly to the firms

Firms act strategicallyNot just greater potential harm merger (e.g. high shares)

Remedies agreed in Phase I are likely to beInsufficient (Type 2 error) if competition issues are complex

and/or much for the firms to fight forBut too stringent (Type 1 errors) if competition issues are

relatively straightforward and/or delay is costly to firms

Issues on which we would particularly welcome discussion

Any improvements on this paper!

Consistency of Ph.I and Ph.II reports as data sourcesE.g. our market share filter, reporting of entry barriers

Appropriate econometric techniques for our datasetIncluding when we move to direct use of market data

c150 mergers * ave.14 markets per merger = >2,000 obs.