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Mergers A merger is a transaction that results in the transfer of ownership and control of a corporation. Jimmy Stepanian

What is Mergers ?& Its Type By Jimmy Stepanian

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Page 1: What is Mergers ?& Its Type By Jimmy Stepanian

Mergers

A merger is a transaction that results in the transfer of ownership and control of a corporation.

Jimmy Stepanian

Page 2: What is Mergers ?& Its Type By Jimmy Stepanian

3 Types of MergersEconomists distinguish between three types of mergers:

1. Horizontal

2. Vertical

3. Conglomerate

Page 3: What is Mergers ?& Its Type By Jimmy Stepanian

Horizontal mergers A horizontal merger results in the consolidation of firms that are direct rivals—that is, sell substitutable products within overlapping geographic markets.Examples: Boeing-McDonnell Douglas; Staples-Office Depot(unconsummated); Chase Manhattan-Chemical Bank; Southern Pacific RR-Sante Fe RR; Pabst-Blatz; LTV-Republic Steel; Konishiroku Photo-Minolta.

Page 4: What is Mergers ?& Its Type By Jimmy Stepanian

Vertical Mergers The merger of firms that have actual or potential buyer-seller relationships

Examples: Time Warner-TBS; Disney-ABC Capitol Cities; Cleveland Cliffs Iron-Detroit Steel; Brown Shoe-Kinney, Ford-Bendix.

Page 5: What is Mergers ?& Its Type By Jimmy Stepanian

Conglomerate mergers

Consolidated firms may sell related products, share marketing and distribution channels and perhaps production processes; or they may be wholly unrelated.

•Product extension conglomerate mergers involve firms that sell non-competing products use related marketing channels of production processes.

Examples: Cardinal Healthcare-Allegiance; AOL-Time Warner; Phillip Morris-Kraft; Citicorp-Travelers Insurance; Pepsico-Pizza Hut; Proctor & Gamble-Clorox.

Page 6: What is Mergers ?& Its Type By Jimmy Stepanian

•Market extension conglomerate mergers join together firms that sell competing products in separate geographic markets.

Examples: Scripps Howard Publishing—Knoxville News Sentinel; Time Warner-TCI; Morrison Supermarkets-Safeway;SBC Communications-Pacific Telesis

•A pure conglomerate merger unites firms that have no obvious relationship of any kind.

Examples:BankCorp of America-Hughes Electronics ;R.J. Reynolds-Burmah Oil & Gas; AT&T-Hartford Insurance

Page 7: What is Mergers ?& Its Type By Jimmy Stepanian

Anticompetitive Effects of MergersIssue: When and how are mergers welfare-reducing (that is, result in a post-merger decrease in TS ?

•Horizontal mergers eliminate sellers and hence reshape market structure. Recall that the structuralists believe that market structure is the primary determinant of market performance.

•Mergers may result in market foreclosure. For example, the Justice Department feared that Microsoft's proposed acquisition of Intuit would result in a foreclosure of the market for personal finance software.

• Mergers may diminish potential competition. For example, the acquisition of Clorox by Proctor & Gamble eliminated P&G as a prime potential entrant in the market for household bleach.

Page 8: What is Mergers ?& Its Type By Jimmy Stepanian

Horizontal mergers have a direct impact on seller concentration (as

measured by the concentration ratio or the Herfindahl index).

Hence the potential to diminished competition is clear to see.

Remember the formula from the Cournot Model:

npMCP

1

Where n is the number of sellers. A merge reduces n, hence increases the price-cost margin and reduces TS, other things being equal.

Page 9: What is Mergers ?& Its Type By Jimmy Stepanian

The Williamson contribution 1

1Oliver Williamson. “Economies as an Antitrust Defense: The Welfare Tradeoffs,” American Economic Review, March 1968.

It would seem at first blush that horizontal mergers would invariably be welfare-reducing. However, if the consolidation of direct rivals leads to greater cost efficiency, then a horizontal merger could (in theory at least) be welfare-enhancing.

Page 10: What is Mergers ?& Its Type By Jimmy Stepanian

Welfare trade-offs of a horizontal merger

Oliver Williamson contends thata horizontal merger can bewelfare-enhancing, even if

the post-merger marketstructure is monopolistic. Why? Because

the merger may result in greatertechnical/cost efficiency.

Page 11: What is Mergers ?& Its Type By Jimmy Stepanian

QC

Price

Quantity0

A1

A2

D

QM

PM

PC

AC’

AC

The efficiencygain from the merger

is indicatedby the shift from AC to

AC’ If area A2 exceedsarea A1, the mergerincreases the total surplus (TS)

Audio explanation (wav)

Page 12: What is Mergers ?& Its Type By Jimmy Stepanian

Measuring the Welfare TradeoffsLet A1 be computed by

))((21

1 QPA

Let A2 be computed by:

MQACA 2

If A1 = A2, the merger is

welfare-neutral

Page 13: What is Mergers ?& Its Type By Jimmy Stepanian

3 2 1 1/2

5 0.43 0.28 0.13 0.06

10 2.00 1.21 0.55 0.26

15 10.37 5.76 2.40 1.10

PP

Percentage Cost Reduction Sufficient to Offset Percentage Price Increases for Selected Values of . Hear audio explanation (wav)

Source: Viscusi, Vernon, and Harrington, Table 7.1, p. 200

Page 14: What is Mergers ?& Its Type By Jimmy Stepanian

Vertical and conglomerate mergers do not affect market structure (e.g.,

seller concentration) directly. As you will discover subsequently, these

types of mergers mergers can nevertheless have anticompetitive

consequences.

Jimmy Stepanian