Structural remedies as a signaling device☆

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Highlights

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    We analyze the effects of remedies on merger activity.

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    Merger efficiencies are unobservable ex ante.

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    We investigate in how far remedies can be used as signaling devices.

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    An efficient merger type is doomed to over-fix with its divestiture proposal.

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    This holds in a pooling and possibly also in a separating equilibrium.

Abstract

We analyze the effects of structural remedies on merger activity when the Antitrust Agency (AA) cannot observe a proposed merger’s efficiency type. Provided the AA follows a consumer surplus standard, an efficient merger type is doomed to over-fix with its divestiture proposal in a pooling equilibrium, which is also possible under separation.

Introduction

While mergers in oligopolistic markets are typically anticompetitive, merger synergies can make a merger desirable from a social or a consumer perspective. If synergies are rather weak, remedies may be offered by the merging parties to effectively protect competition and to remove any competition concern the Antitrust Agencies (AA) may have. We consider remedies in the most usual form of physical asset sales (“structural remedies”, “divestitures”) which are designed and proposed to the AA by the merging firms and can be either rejected or accepted. In practice, the AA follows a consumer surplus (CS) standard according to which such proposals are approved which do not increase the expected post-merger price level (Whinston, 2007). Divestitures enlarge the scope for approvable mergers in the presence of merger synergies (Dertwinkel-Kalt, Wey, 2016, Medvedev, 2007). If the merger synergy, however, is very weak or absent, only under very restrictive conditions a re-allocation of productive assets through structural remedies may satisfy the consumer surplus standard (Vergé, 2010).

We assume asymmetric information between the merging firms and the AA: while firms have precise knowledge about the synergies a merger creates, the AA is uncertain about a merger’s synergy level. In line with merger practice, we suppose that the merging firms must make a remedial offer which is either accepted (in which case the merger goes through) or rejected (in which case the merger is blocked) by the AA.1 Our main research question is how the merging firms’ remedy choice is affected by asymmetric information and whether the remedy can be used to signal the merger’s synergy type.2

Within the narrow context of merger control, it is natural to assume that the size of the proposed divestiture is the only potential signaling device available. The divestiture level can be used as a signaling device as more efficient mergers stay profitable even if a relatively large stock of capital has to be divested. We find that only a pooling equilibrium exists in which both efficient and inefficient mergers are cleared whenever the difference in their efficiency levels is relatively small or if inefficient mergers are unlikely. As firms cannot separate through signaling, also rather inefficient mergers are cleared which would have been blocked by the AA under complete information. As the expected post-merger price level must not exceed the pre-merger price level, the efficient type is doomed to over-fix by proposing to divest more than under complete information.

A separating equilibrium exists only if the pooling divestiture is not profitable for the inefficient type. Such a separating equilibrium is backed by the more efficient type by proposing a “large” divestiture (possibly above the equilibrium divestiture under complete information) to deter the inefficient type from mimicking its behavior.3 Both the pooling and the separating equilibrium outcomes provides a new rationale for the often mentioned phenomenon of “over-fixing” associated with remedies. In contrast to Vasconcelos’ (2010) critique of over-fixing, consumers benefit in our setting from the efficient firm’s “over-fixed” divestiture level.4

Section snippets

The model

Suppose a Cournot market with N ≥ 3 firms and a downward sloping inverse demand function p(X), with p′(X) < 0, where p is the market price and X stands for the industry’s total output of a homogenous product. We assume p′(X)+xip′′(X)<0holdsforall1≤i≤N,which guarantees that each firm’s reaction function slopes downward with slope between −1 and 0. Each firm i has a capital stock ki and produces quantity xi at costs ci(xi, ki). Prior to a merger, let p* denote the equilibrium market price and πi*

Analysis

Let ppm(sθ) denote the post-merger price following a merger of synergy type sθ with divestiture Δ. Such a merger-proposal will be approved if and only if p*−E(ppm)≥0orbhppm(Δ,sh)+blppm(Δ,sl)≤p*,where the left-hand side of (7) denotes the expected post-merger price, given the AA’s beliefs bθ on the probabilities of facing a merger proposal of type θ=h,l.

Ex-ante, the AA’s beliefs are bl=ρ and bh=1−ρ. There is only one instance in which the AA can update its belief such that it can infer the

Conclusion

We analyzed the effects of structural remedies as a signaling device in a standard Cournot oligopoly with homogeneous products under a consumer welfare standard, where merging parties and the AA hold asymmetric information. Typically, firms cannot signal their efficiency level such that anticompetitive mergers may be implemented which would have been blocked in a complete-information scenario. Only under certain conditions, efficient firms can separate via proposing a particularly large

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We would like to thank Nina Bobkova for her helpful comments.

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