Securities Act of 1933

This legislation requires that securities offered to the public be registered with the government to protect investors by making issuers disclose all material facts regarding the security issue. Registration requires, but does not guarantee, that the facts represented in the registration statement and prospectuses are accurate. The law makes providing inaccurate or misleading statements in the sale of securities to the public punishable with a fine, imprisonment, or both. The registration process involves a description of the company’s properties and business, a description of the securities, information about management, and financial statements certified by public accountants.

Securities Exchange Act of 1934

The Securities Exchange Act extends disclosure requirements stipulated in the Securities Act of 1933 to include securities already trading (so-called seasoned or secondary issues) on the national exchanges. The Act also established the Securities and Exchange Commission (SEC), whose purpose is to protect investors from fraud by requiring full and accurate financial disclosure by firms offering stocks, bonds, and other securities to the public. In 1964, coverage was expanded to include securities traded on the Over-the-Counter (OTC) Market. The act also covers proxy solicitations (i.e., mailings to shareholders requesting their vote on a particular issue) by a company or shareholders. The 2010 Dodd-Frank Wall Street Reform and Consumer Protections Act (Dodd-Frank Act) strengthened the SEC enforcement powers by allowing the commission to impose financial penalties against any person, rather than against just entities.

The Williams Act: Regulation of Tender Offers

Passed in 1968, the Williams Act consists of a series of amendments to the Securities Act of 1934 intended to protect target shareholders from fast takeovers in which they do not have enough time to assess adequately an acquirer’s offer. This protection was achieved by requiring more disclosure by the bidding company, establishing a minimum period during which a tender offer must remain open and authorizing targets to sue bidding firms. The disclosure requirements of the Williams Act apply to anyone, including the target, asking shareholders to accept or reject a takeover bid. The major sections of the Williams Act as they affect M&As are in Sections 13(D) and 14(D). The Williams Act requirements apply to all types of tender offers, including those negotiated with the target firm (i.e., negotiated or friendly tender offers), those undertaken by a firm to repurchase its own stock (i.e., self-tender offers), and those that are unwanted by the target firm (i.e., hostile tender offers).¹⁴

The Sarbanes-Oxley Act of 2002

The SOA was signed in the wake of the egregious scandals at such corporate giants as Enron, MCI WorldCom, ImClone, Qwest, Adelphia, and Tyco and has implications ranging from financial disclosure to auditing practices to corporate governance. Section 302 of the act requires quarterly certification of financial statements and disclosure controls and procedures for CEOs and CFOs. Section 404 requires most public companies to certify annually that their internal control system is operating successfully and to report material weaknesses in internal controls to analysts when making earnings forecasts.¹⁷ The legislation, in concert with new listing requirements at public stock exchanges, requires a greater number of directors on the board who do not work for the company (i.e., so-called independent directors). The Act also requires board audit committees to have at least one financial expert, while the full committee must review financial statements every quarter after the CEO and chief financial officer certify them. The SOA also provides for greater transparency, or visibility into a firm’s financial statements and greater accountability. However, the flagrant practices of some financial service firms (e.g., AIG, Bear Stearns, and Lehman Brothers) in recent years cast doubt on how effective the SOA has been in achieving its transparency and accountability objectives.

Empirical studies of the SOA’s effectiveness give mixed results. As noted in a number of studies (see Chapter 13), there is growing evidence that the monitoring costs imposed by Sarbanes-Oxley have been a factor in many small firms’ going private since the introduction of the legislation.¹⁸ The overall costs of corporate boards soared post-SOA due to sharply higher director compensation. However, shareholders of large firms that are required to overhaul their existing governance systems under Sarbanes-Oxley may in some cases benefit as new shareholder protections are put in place. Moreover, the run-up in target share prices before they are publicly announced has decreased significantly since the SOA’s introduction, perhaps reflecting improved accountability and regulatory oversight of bidder managers and boards involved in deals.¹⁹

In some instances, the SOA’s requirements appear to be redundant. New York Stock Exchange listing requirements far exceed SOA’s auditor-independence requirements. Companies must have board audit committees consisting of at least three independent directors and a written charter describing its responsibilities in detail. Moreover, the majority of all board members must be independent, and non-management directors must meet periodically without management. Board compensation and nominating committees must consist of independent directors. Shareholders must be able to vote on all stock option plans.

The SOA also created a quasi-public oversight agency, the Public Company Accounting Oversight Board (PCAOB). The PCAOB is charged with registering auditors, defining specific processes and procedures for compliance audits, quality control, and enforcing compliance with specific SOA mandates.

Fair Disclosure

On August 7, 2018, entrepreneurial icon and Tesla Inc. (Tesla) Chairman and CEO Elon Musk used Twitter to announce “Am considering taking Tesla private at $420 (per share). Funding secured.”²⁰ Once again showing the power on social media to move markets, the firm’s stock immediately soared. But did he violate US Securities and Exchange Commission rules?

He did not violate SEC regulations by using social media but he could be accused of stock manipulation if his statement was not true, particularly about the funding for such a deal being in place. Known as the Reed Hastings Rule, the SEC determined using social media as a means of disclosing material information appropriate under certain conditions after Netflix CEO Reed Hastings posted on Facebook in 2012 that views on his firm’s video streaming service “had exceeded 1 billion hours for the first time.” The SEC declared social media “perfectly acceptable” as long as investors are alerted and access is not restricted. What raised eyebrows was the veracity of Musk’s claim about having funding for such a deal. The concern is that he might have violated the SEC’s Fair Disclosure Rule.

In late September, the SEC initiated a lawsuit against Musk for alleged “false and misleading” statements that could have prevented him from running any public company. On September 29, 2018, Musk settled with the SEC by stepping down as chairman of Tesla for 3 years (but remaining as chief executive) and paying a fine of $20 million. In addition, Tesla agreed to hire several new independent board members and to establish a new committee of directors and create controls to oversee Musk’s public communications.

The US Securities and Exchange Commission adopted Regulation FD (Fair Disclosure) on August 15, 2000 to address concerns about the selective release of information by publicly traded firms. Regulation FD requires that a publicly traded firm that discloses material nonpublic information to certain parties, such as stock analysts and individual shareholders, must release that information to the general public.

Critics warned that less information about a firm’s share price would be provided by managers concerned about litigation. In fact, there are indications that there has been an increase in voluntary disclosure. However, the greater availability of information may have done little to dampen earnings’ “surprises” and to lower stock price volatility. Studies provide conflicting results, with one study reporting an increase in share price volatility and another showing no change following the implementation of Regulation FD.²¹

Consistent with the trend toward increased voluntary disclosure of information, the fraction of US acquirers disclosing synergy estimates when announcing a deal has increased from 7% in 1995 to 27% of total transactions in 2008, with much of the increase coming since the introduction of Regulation FD. Some researchers argue that public disclosure of synergy can help the acquirer communicate the potential value of the deal to investors lacking information available to the firm’s board and management, enabling investors to make more informed decisions. In particular, synergy disclosure can result in significantly higher acquirer announcement date financial returns by allaying investor fears that the offer price is excessive.²² Others contend that disclosing such information is self-serving, since it helps the acquirer’s board and management gain shareholder support for the transaction.²³

Recent evidence suggests that acquirers may use press releases to manipulate deals in other ways. That is, acquirers in stock deals increase the number of stories after the start of merger negotiations but before the public announcement that an agreement had been reached. This media blitz may be an effort to generate a temporary increase in their share price to reduce the number of acquirer shares that must be issued for each target share outstanding. This minimizes potential dilution of acquirer shareholders.²⁴ For example, assume the target is to receive $100 per share in terms of acquirer stock, valued at $50 per share at the time of the agreement. Therefore, the acquirer would have to issue two shares of its stock for each acquirer share. However, if the acquirer’s stock price increases to $105 per share, only 0.9524 acquirer shares ($100/$105) would have to be issued for each target share.

About one-fifth of US acquirers reveal to the public their intentions to make acquisitions when they announce the issuance of new debt or equity, frequently well in advance of an M&A announcement. Such firms often raise more money than needed to complete the subsequent acquisition. This suggests that the announcement of intent is largely designed to justify raising more money than necessary to complete any subsequent deal and to mask how the excess funds will actually be used.²⁵

The Sherman Act

Passed in 1890, the Sherman Act makes illegal all contracts, combinations, and conspiracies that restrain trade “unreasonably.” Examples include agreements to fix prices, rig bids, allocate customers among competitors, or monopolize any part of interstate commerce. Section I of the Sherman Act prohibits new business combinations resulting in monopolies or in a significant concentration of pricing power in a single firm. Section II applies to firms that already are dominant in their targeted markets. The act applies to all transactions and businesses involved in interstate commerce or, if the activities are local, all transactions and business “affecting” interstate commerce. Most states have comparable statutes.

The Clayton Act

Passed in 1914, the Clayton Act was created to outlaw certain practices not prohibited by the Sherman Act and to help government stop a monopoly before it developed. Section 5 of the act made price discrimination between customers illegal, unless it could be justified by cost savings associated with bulk purchases. Tying of contracts—in which a firm refuses to sell certain important products to a customer unless the customer agrees to buy other products from the firm—also was prohibited. Section 7 prohibits one company from buying the stock of another company if their combination results in reduced competition. Interlocking directorates also were made illegal when the directors were on the boards of competing firms.

Unlike the Sherman Act, which contains criminal penalties, the Clayton Act is a civil statute. The Clayton Act allows private parties that were injured by an antitrust violation to sue in federal court for three times their actual damages to encourage private lawsuits. Such lawsuits augment public antitrust law enforcement resources. If the plaintiff wins, the costs must be borne by the party that violated the prevailing antitrust law, in addition to the criminal penalties imposed under the Sherman Act. Public antitrust regulators can encourage private antitrust lawsuits by signaling the government’s commitment to fostering competition. To curb anticompetitive abuses, the signal must be highly visible and potentially costly to violators of antitrust laws.²⁷

Acquirers soon learned how to circumvent the original statutes of the Clayton Act of 1914, which applied to the purchase of stock. They simply would acquire the assets, rather than the stock, of a target firm. Under the Celler-Kefauver Act of 1950, the Clayton Act was amended to give the FTC the power to prohibit asset as well as stock purchases.

The Federal Trade Commission Act of 1914

This act created the FTC, consisting of five full-time commissioners appointed by the president for a 7-year term. The commissioners have a support staff of economists, lawyers, and accountants to assist in the enforcement of antitrust laws.

The Hart-Scott-Rodino (HSR) Antitrust Improvements Act of 1976

Acquisitions involving companies of a specific size cannot be completed until certain information is supplied to the federal government and a specified waiting period has elapsed. The premerger notification allows the FTC and the DoJ time to challenge acquisitions believed to be anticompetitive before they are completed. Once the merger has taken place, it is often difficult to break it up.

Parties proposing a deal meeting certain size requirements file with both the FTC and DoJ, but only one antitrust agency will review the proposed merger. Since both the FTC and the DoJ share jurisdiction over transactions requiring review, deals are assigned on a case-by-case basis depending on which agency has more expertise with the industry involved and resources available to conduct the review. This is known as the “clearance process.” The reviewing agency may issue an “early termination” of the waiting period or allow the waiting period to elapse, in either case allowing the deal to close.

Failing to get regulatory approval can be costly in terms of having to pay target shareholders termination fees if negotiated as part of the contract, demands on company resources in performing target due diligence, legal and consulting fees, management distraction, etc. One study finds that the failure to get antitrust regulatory approval results in a reduction in acquirer shareholder value of about 2.8%. Therefore, lobbying before deal announcements to take advantage of political connections makes sense and such efforts are frequently associated with more favorable review outcomes, especially in horizontal deals.²⁸

Alternatively, the regulators can request additional information in a so-called “second request.” At the end of the process, the reviewing agency may let the waiting period expire or decide to challenge the deal by filing a preliminary injunction in federal court pending an administrative trial on the merits of the case. A challenge stops the parties from closing the deal. If challenged, the deal may still be approved as long as the filing parties are willing to make changes to the proposed merger acceptable to regulators. Fig. 2.1 illustrates the premerger notification and review process, and Table 2.2 provides a summary of 2018 prenotification filing requirements.

Procedural Rules

A DoJ antitrust lawsuit is adjudicated in the federal courts. When the FTC initiates the action, it is heard before an administrative law judge at the FTC, whose ruling is subject to review by FTC commissioners. Criminal actions are reserved for the DoJ, which may seek fines or imprisonment for violators. Individuals and companies also may file antitrust lawsuits. The FTC reviews complaints that have been recommended by its staff and approved by the commission. The commission then votes whether to accept or reject the hearing examiner’s findings. The decision of the commission then can be appealed in the federal circuit courts. As an alternative to litigation, a company may seek to negotiate a voluntary settlement of its differences with the FTC. Such settlements usually are negotiated during the review process and are called consent decrees. The FTC then files a complaint in the federal court along with the proposed consent decree. The federal court judge routinely approves the consent decree.

The Consent Decree

A typical consent decree may consist of both structural and behavioral remedies. Structural remedies generally require the party or parties seeking regulatory approval to change the structure of their businesses. This usually involves the sale of assets or businesses in areas where they compete directly. Structural remedies differ from behavioral remedies, which are designed to regulate the future conduct of the relevant party or parties (for example, by regulating the prices which a party may charge). Behavioral remedies may require significant monitoring by regulators to ensure compliance.

In mid-2018, German chemical giant Bayer agreed to a structural remedy involving the sale of agricultural businesses and assets valued at $9 billion to chemical company BASF to get US regulatory approval to complete its $66 billion takeover of US based Monsanto. In the largest antitrust related divestiture on record, the US regulators reasoned that the sell-off offered customers a viable alternative to Bayer for certain agricultural chemicals. Similarly, the Justice Department’s approval of the $69 billion merger between CVS Health and health insurer Aetna in late 2018 required Aetna to sell its private Medicare drug plans. Regulators believed this action would provide consumers with more choices and would help restrain the potential pricing power of the combined businesses. As a condition of approving the January 2011 acquisition of NBC Universal (NBCU) by Comcast, Comcast agreed to several behavioral remedies that would impact its future conduct of the combined businesses. Comcast committed to arbitrate disputes with other cable systems concerning their access to NBCU’s cable channels.

If a potential acquisition is likely to be challenged by the regulatory authorities, an acquirer may seek to negotiate a consent decree in advance of the deal. In the absence of a consent decree, a buyer often requires that an agreement of purchase and sale includes a provision allowing the acquirer to back out of the transaction if it is challenged by the FTC or the DoJ on antitrust grounds. Consent decrees do seem to limit potential increases in business pricing power following a merger by creating viable competitors.³²

Antitrust Guidelines for Horizontal Mergers

Understanding an industry begins with analyzing its market structure. Market structure may be defined in terms of the number of firms in an industry; their concentration, cost, demand, and technological conditions; and ease of entry and exit. Intended to clarify the provisions of the Sherman and Clayton acts, the DoJ issued in 1968 largely quantitative guidelines, presented in terms of specific market share percentages and concentration ratios, indicating the types of M&As it would oppose. Concentration ratios were defined in terms of the market shares of the industry’s top four or eight firms. The guidelines have been revised to reflect the role of both quantitative and qualitative data. Qualitative data include factors such as the enhanced efficiency resulting from a combination of firms, the financial viability of potential merger candidates, and the ability of US firms to compete globally.

In 1992, both the FTC and the DoJ announced a new set of guidelines indicating that they would challenge mergers creating or enhancing market power, even if there are measurable efficiency benefits. Market power is defined as a situation in which the combined firms will be able to profitably maintain prices above competitive levels for a significant period. The 1992 guidelines were revised in 1997 to reflect the regulatory authorities’ willingness to recognize that improvements in efficiency over the long term could more than offset the effects of increases in market power. On August 19, 2010, the guidelines were updated to give regulators more leeway to challenge mergers than previously. However, they also raised the thresholds for determining if a merger would cause anticompetitive concentration. The new guidelines closely resemble the European Union’s antitrust guidelines. In general, horizontal mergers are most likely to be challenged by regulators. Vertical mergers—those involving customer-supplier relationships—are considered much less likely to result in anticompetitive effects, unless they deprive other firms access to an important resource.

As part of the review process, regulators consider customers and the prospect for price discrimination, market definition, market share and concentration, unilateral effects, coordinated effects, ease of entry, realized efficiencies, potential for business failure, and partial acquisitions. These factors are considered next.

Market Share and Concentration

The number of firms in a market and their respective shares determine market concentration. Such ratios measure how much of the total output of an industry is produced by the “n” largest firms in the industry. To account for the distribution of firm size, the FTC measures concentration using the Herfindahl-Hirschman Index (HHI), which is calculated by summing the squares of the market shares for each firm competing in the market. For example, a market consisting of five firms with market shares of 30%, 25%, 20%, 15%, and 10%, respectively, would have an HHI of 2250 (30² + 25² + 20² + 15² + 10²). Note that an industry consisting of five competitors with market shares of 70%, 10%, 5%, 5%, and 5%, respectively, will have a much higher HHI score of 5075, because the process of squaring the market shares gives the greatest weight to the firm with the largest market shares.³³

The HHI ranges from 10,000 for an almost pure monopoly to approximately 0 in the case of a highly competitive market. The index gives more weight to the market shares of larger firms to reflect their relatively greater pricing power. The FTC scoring system described in Fig. 2.2 is one factor in determining if the FTC will challenge a proposed deal.

Almost one third of industries in the United States in 2015 were considered highly concentrated under current federal antitrust standards. This compares to approximately one fourth in 1996.³⁴ In many cases, this increased concentration is driven by technological innovation and the need for consolidation in the face of intensifying global competition. Mergers offer economies of scale and scope that increase efficiency and innovation³⁵ and in some instances preserve jobs at firms too weak to remain competitive on their own. Reflecting these factors, there appears to be little evidence of a widespread or systematic decline in the degree of competition in the US despite the increase in market concentration during the last 20 years. While in the aggregate this may be true, at the individual industry level, the impact of an increase in competition can be ambiguous: it can be a result of intensified competition (as argued above) or contribute to increased pricing power for the remaining firms in the industry.³⁶

Antitrust Guidelines for Vertical Mergers

In supply chains,³⁷ many firms pursue vertical integration with their upstream (i.e., distributors) or downstream (i.e., suppliers) partners to realize competitive advantages.³⁸ Supply chains contain multiple levels with several firms competing at each level. Vertical mergers may become a concern if an acquisition by a supplier of a customer prevents the supplier’s competitors from having access to the customer. Alternatively, the acquisition by a customer of a supplier could become a concern if it prevents the customer’s competitors from having access to the supplier.

Recent theoretical work expands the circumstances under which vertical mergers can encourage anticompetitive conditions. Vertical mergers, so goes the argument, increase profits from collusion and therefore the incentive to collude. They create cost differences between integrated and non-integrated competitors. The vertically integrated firms are able to improve their total profit margins because they are buying downstream inputs at cost, while the non-integrated firms pay prices for the same inputs which include a profit margin. The integrated firm can set prices by implicitly threatening aggressive price discounting, as they in theory have higher profit margins, if non-integrated firms do not follow suit. By offering the same prices as the integrated competitor, the non-integrated firm can enjoy higher profits. Thus, vertical integration can offer significant benefits by colluding.³⁹

While rare, vertical mergers are more likely to result in regulatory review when firms dominant in their respective markets integrate vertically. On November 20, 2017, AT&T’s $85 billion planned takeover of Time Warner Inc. was blocked by the US Justice Department, which expressed concern that the combination would lead to higher prices for traditional pay-TV and limit the expansion of low cost streaming services threatening AT&T’s DirecTV business.⁴⁰ The proposed combination is considered a vertical merger, because AT&T’s primary business is providing phone service, while Time Warner’s focus is on TV and movie production. The merger would combine the nation’s second-largest phone company and largest pay-TV provider with Time Warner’s assets including HBO, TBS, TNT, Cartoon Network and Warner Bros. The Justice Department sought to block the merger even though it had approved a similar merger between Comcast and NBCUniversal in 2011 arguing that the AT&T-Time Warner deal was three times larger. On June 12, 2018, a federal judge dismissed the Justice Department’s case and approved the AT&T’s takeover of Time Warner, without attaching any conditions to his ruling.

Antitrust Guidelines for Collaborative Efforts

Collaborative efforts are horizontal agreements among competitors such as joint ventures and strategic alliances. Regulators are less likely to block a collaborative effort if (i) the participants have continued to compete through independent operations or through other collaborative efforts; (ii) the financial interest in the effort by each participant is relatively small; (iii) each participant’s ability to control the effort is limited; (iv) effective safeguards prevent information sharing; and (v) the duration of the collaborative effort is short.

Revisions to Intellectual Property Guidelines

On January 12, 2017, US government regulators issued revised antitrust guidelines pertaining to intellectual property. Ownership of intellectual property is subject to the guidelines applicable to other forms of property. However, the new guidelines incorporate recent Supreme Court rulings that a patent does not necessarily confer market power on the patent holder. That is, simply refusing to convey the use of such property to competitors generally does not violate antitrust law. Also, prices charged for granting others the right to use intellectual property are subject to the “rule of reason.”⁴¹

When Are Antitrust Regulators Most Likely to Intervene?

The likelihood of antitrust intervention in horizontal mergers is less when foreign import competition is high, an industry is difficult to monopolize due to low entry barriers, existing competitors have the capacity to increase supply, and mergers are motivated by efficiency gains. Regulatory authorities are more likely to intervene when market concentration is high.

Antitrust enforcement has not been consistent with the stated aim of protecting consumers as the regulatory agencies do not systematically select cases which appear to be harmful to consumers in general or customers of local businesses. Regulators can be influenced to intervene on behalf of competitors who tend to benefit from preventing a rival from consummating a merger. Local and less specialized competitors who are most likely to face pressure from gains in efficiency resulting from a merger are the ones most likely to benefit.⁴²

Trends in Enforcement Efforts

Enforcement efforts ebb and flow with changes in presidential administrations and political and economic philosophies. During much of the decade ending in 2010, business combinations among direct competitors tended to be less restrictive as they were viewed as a means of achieving greater operating efficiency. In recent years, enforcement efforts have become more aggressive, especially in such concentrated industries as telecommunications, airlines, and media.

Just the threat of regulatory intervention appears to have been a major factor in deterring the proposed tie-ups between Sprint and T-Mobile and 21st Century Fox and Time Warner in 2014. In neither instance, did the Justice Department or the Federal Communications Commission (FCC) announce a formal position on either deal. The Sprint-T-Mobile deal would have reduced the number of wireless competitors from four to three and the Fox-Time Warner combination would have joined the two largest movie studios and two of the five largest television producers. In 2015 and 2016, other potential tie-ups that were abandoned due to regulatory investigations included the Comcast/Time Warner Cable, Applied Materials/Tokyo Electron, GE/Electrolux, and Bumble Bee/Chicken of the Sea deals.

The impact of failing to receive regulatory approval can be very costly for acquirers. In mid-2016, oil services providers Halliburton and Baker Hughes called off their planned $35 billion merger. The decision was made after a lengthy regulatory review in which the US Justice Department decided to block the deal. Halliburton had to pay Baker Hughes a $3.5 billion termination fee, one of the largest on record, to exit the merger agreement. The amount was included in the merger agreement to reassure Baker Hughes that Halliburton expected the deal to close.

How Business Platform Strategies Complicate Antitrust Enforcement

A business platform strategy is one in which a firm creates value by expediting transactions between consumers and producers. To do so, businesses create large, scalable communities/networks of users that can be accessed on demand. Examples include Facebook, Apple, Google/YouTube, Alibaba, and Uber. Successful platforms build strong barriers to entry for potential competitors in the form of extensive networks or installed user bases and operate at a scale that results in their having extremely low user acquisition and retention costs. See Chapter 4 for a more detailed discussion of this subject.

Current antitrust law does not easily address market dominance when it develops in this manner. The current law focuses on how a proposed M&A impacts output and prices and in turn consumer welfare to determine if it is anticompetitive. But that framework does not apply easily to businesses that grow through platform strategies.

Amazon.com is the premier example of how a successful platform strategy contributes to market dominance. Amazon has become the global hub of online retail commerce. It has done so by building a highly scalable infrastructure to support a growing volume of users attracted by the convenience of having access to the vast array of products offered at prices that may be below cost. This has the effect of increasing scale to drive down infrastructure expenses per dollar of revenue. Not only can this infrastructure be used to dominate specific lines of business but also related lines of business. Amazon is now in a variety of seemingly unrelated lines of business ranging from a delivery and logistics network and an auction house to a major book publisher, a TV and film producer, and hardware manufacturer to a leading supplier of cloud services, fashion design, and grocery business.

The common element is that each line of business generates data on consumer and business buying behaviors which can be used to determine pricing strategies, achieve optimal inventory management, and to anticipate future product offerings in various markets. A recent illustration of the value of this data is Amazon’s foray into the grocery business involving the acquisition of Whole Foods in late 2016. Amazon plans to use its database of consumer information to determine the number and type of products and in what quantities to offer products at various store locations.

The end result of successful platform strategies is that they tend to concentrate market power in a relatively few businesses. Once a business has a dominant position in a market, it may be able to stifle innovation of new products that could threaten their own product offering and to raise prices with relative ease. Note that de facto price increases can be achieved by lowering product quality without actually raising selling prices. Firms competing on the basis of achieving platform dominance in multiple markets may choose to vertically integrate by owning valuable content, which can be sold across markets. Such firms also can restrict competitor access to this content.

If platform strategies do indeed lead to natural monopolies,⁴³ regulators are faced with few alternatives. One option is to let online competitors govern the market place. Antitrust regulators can help sustain competition by limiting the extent to which a firm’s platform is used in other markets, to lower the threshold for proving predatory pricing, and banning vertical integration by those firms operating platform businesses.⁴⁴ Another option is for regulators to approve business combinations involving platform businesses that increase efficiency through economies of scale to achieve savings that can be passed onto customers. Regulators can then treat such businesses as utilities and regulate what they can charge their customers and the services they may offer.

Impact of Antitrust Actions on Firm Value

Empirical studies of regulatory announcements to investigate potential antitrust violations on firm value confirm that initially the share prices of the firms involved drop. However, they recover quickly if the concessions required to gain approval are seen by investors as minimal.⁴⁵ Other studies show that the impact of legislative changes or regulatory policy reform on a firm’s share price varies by industry. For example, financial services firms tend to be more regulated than non-financial firms with regulators often having more enforcement discretion. Research seems to indicate that investors view new merger control legislation establishing clearer guidelines as positive, because such laws reduce the discretion (and implicitly the perceived arbitrariness) given to regulators.⁴⁶

The Impact of Politics on Gaining Regulatory Approval

M&As involve a highly regulated process; as such, they are susceptible to political influence. At the federal level, the FTC and DoJ may be influenced by political concerns. Pressures often are even greater at the local level. Concerned about re-election and possibly about career opportunities once out of public office, local politicians can see contributions dry up from corporations, their reputations suffer, and constituents subject to job losses when an important local business is acquired. As a result, firms contributing to politicians are actually less likely to be acquired and, if acquired, more likely to command higher takeover premiums since their political connections may make their growth opportunities more valuable. Moreover, the elapsed time between the announcement date and closing may be lengthy because of politically motivated intervention by states attorneys general on antitrust grounds or alleged securities violations.⁴⁷

State Antitakeover Laws

Supporters of laws providing protection to target firm shareholders argue that such laws improve deal efficiency, protect minority shareholders, and ultimately generate higher returns for target shareholders. The source of the efficiency gains in the takeover process comes from the likelihood of competing offers and more time for allowing shareholders to consider such bids. Critics argue that such laws increase barriers to takeovers and heighten the potential for management entrenchment. They also argue that such laws lead to less efficiency because of higher transaction costs or overbidding by the acquirer due to increased competition among bidders. Others argue that increased protection is a zero sum game benefitting target shareholders at the expense of acquirer shareholders by transferring gains from bidders to targets and leaving total synergies unchanged.⁵¹

With 66% of all Fortune 500 companies as of 2017 incorporated in Delaware, the state’s corporate law has a substantial influence on publicly traded firms. The next most popular state is Nevada with 15%. Delaware corporate law generally defers to the judgment of business managers and board directors in accordance with the so-called “business judgment rule.” This rule acknowledges that the daily operation of a business is inherently risky and controversial; and, as such, states that the board of directors should be allowed to make decisions without fear of being prosecuted. The rule further assumes that it is unfair to expect those managing a company to make the right decisions all the time. If the courts believe a board acted rationally, there should be no legal repercussions against managers and directors. The major exception is in change of control situations. Here, managers are subject to an enhanced business judgment test. This requires a target board to show there are reasonable grounds to believe that a danger to corporate viability exists and that the adoption of defensive measures is reasonable. While Delaware law is the norm for many companies, firms incorporated in other states often are subject to corporate law that may differ from Delaware law. What follows is a discussion of commonalities across the states.

States regulate corporate charters. Corporate charters define the powers of the firm and the rights and responsibilities of its shareholders, boards of directors, and managers. However, states are not allowed to pass any laws that impose restrictions on interstate commerce or conflict in any way with federal laws. State laws affecting M&As tend to apply only to firms incorporated in the state or that conduct a substantial amount of their business within the state. These laws often contain fair price provisions, requiring that all target shareholders of a successful tender offer receive the same price as those tendering their shares. In an attempt to prevent highly leveraged transactions, some state laws include business combination provisions, which may specifically rule out the sale of the target’s assets for a specific period.⁵²

Other common characteristics of state antitakeover laws include cash-out and control-share provisions. Cash-out provisions require a bidder whose purchases of stock exceed a stipulated amount to buy the remainder of the target stock on the same terms granted those shareholders whose stock was purchased at an earlier date. By forcing acquiring firms to purchase 100% of the stock, potential bidders lacking substantial financial resources are eliminated from bidding. Share-control provisions require that a bidder obtains prior approval from shareholders possessing large blocks of target stock once the bidder’s purchases of stock exceed some threshold level. The latter provision can be troublesome to an acquiring company when the holders of the large blocks of stock tend to support target management.

Antitakeover laws helping to insulate firms from takeover threats can benefit some stakeholders more than others. When shareholder and management interests are misaligned, shareholders may demand greater financial reporting conservatism (transparency) to limit managerial efforts to increase compensation and to make value destroying acquisitions. This benefits debtholders more than shareholders by curtailing excessive dividends to shareholders thereby reducing the potential for financial distress and eventual default.⁵³

State Antitrust and Securities Laws

State laws are often similar to federal laws. Under federal law, states have the right to sue to block mergers, even if the DoJ or FTC does not challenge them. State “blue sky” laws are designed to protect individuals from investing in fraudulent security offerings. State restrictions can be more onerous than federal ones.

Banking

Currently, three agencies review banking mergers. The Office of the Comptroller of the Currency has responsibility for transactions in which the acquirer is a national bank. The FDIC oversees mergers where the acquiring bank or the bank resulting from combining the acquirer and the target will be a federally insured state-chartered bank that operates outside the Federal Reserve System. The third agency is the Board of Governors of the Federal Reserve System (the Fed). It has the authority to regulate mergers in which the acquirer or the resulting bank will be a state bank that is also a member of the Federal Reserve System.

The Dodd-Frank legislation eliminated the Office of Thrift Supervision and transferred the responsibility for regulating savings and loan associations, credit unions, and savings banks (collectively referred to as thrift institutions) to other regulators. Specifically, the Fed will supervise savings and loan holding companies and their subsidiaries; the FDIC will gain supervisory authority of all state savings banks; and the Office of the Comptroller of the Currency will supervise all federal savings banks.

M&A transactions involving financial institutions resulting in substantial additional leverage or in increased industry concentration will also come under the scrutiny of the Financial Stability Oversight Council created by the Dodd-Frank Act to monitor systemic risk. The council is empowered, among other things, to limit bank holding companies with $50 billion or more in assets or a nonbank financial company that is regulated by the Federal Reserve from merging, acquiring, or consolidating with another firm. The council may require the holding company to divest certain assets if the company is deemed to constitute a threat to the financial stability of US financial markets. Under the new legislation, the size of any single bank or nonbank cannot exceed 10% of deposits nationwide. However, this constraint may be relaxed for mergers involving failing banks.

Communications

The FCC is charged with regulating interstate and international communication by radio, television, wire, satellite, and cable. The Commission is responsible for the enforcement of such legislation as the Telecommunications Act of 1996 intended to reduce regulation while promoting lower prices and higher quality services.

One of the FCC’s first major actions under the Trump Administration was to relax media ownership restrictions allowing TV broadcasters to own newspapers in the same market and two of the top four stations in a city. The new rules implemented on November 15, 2017 could lead to mergers among broadcasters, who have long argued that consolidation was necessary to compete with cable and internet companies for local advertising dollars.

On December 15, 2017, the FCC rescinded the so-called “net neutrality rules” that were introduced in early 2015. The rescission enables internet broadband providers, such as AT&T, Comcast, and Verizon, to determine what content they can provide and at what price. The providers can now block or slow down data transmission speeds and seek payments in exchange for faster access on their internet networks. The FCC argued that state and local governments cannot create their own net neutrality rules since internet services crossed state lines and were subject to the so-called “commerce clause.”⁵⁵ Supporters of the net neutrality rules such as Google’s parent Alphabet Inc. and Facebook Inc. contend that eliminating the rules would stifle internet innovation. At the time of this writing, it is unclear how the rescission of the net neutrality regulations at the federal level will impact internet users as California enacted legislation in late 2018 preventing broadband and wireless companies from altering data transmission speeds for different internet users. The US Justice Department, arguing that the move was unconstitutional, sued the state laying the groundwork for a potentially lengthy court battle.

Railroads

The Surface Transportation Board (STB), the successor to the Interstate Commerce Commission (ICC), governs mergers of railroads. Under the ICC Termination Act of 1995, the STB determines if a merger should be approved by assessing the impact on public transportation, the areas currently served by the carriers involved in the proposed transaction, and the burden of the total fixed charges resulting from completing the transaction.

Defense

During the 1990s, the US defense industry underwent consolidation, consistent with the Department of Defense’s (DoD’s) philosophy that it is preferable to have three or four highly viable defense contractors than a dozen weaker firms. Although defense industry mergers are technically subject to current antitrust regulations, the DoJ and FTC have assumed a secondary role to the DoD. Efforts by a foreign entity to acquire national security-related assets also must be reviewed by the Council on Foreign Investment in the United States.

Other Regulated Industries

Historically, the insurance industry was regulated largely at the state level. Under the Dodd-Frank Act, the Federal Insurance Office was created within the US Treasury to monitor all non-healthcare-related aspects of the insurance industry. As a “systemic” regulator, its approval will be required for all acquisitions of insurance companies whose size and interlocking business relationships could have repercussions on the US financial system. The acquisition of more than 10% of a US airline’s shares outstanding is subject to approval of the Federal Aviation Administration. Public utilities are highly regulated at the state level. Like insurance companies, their acquisition requires state government approval.

Discussion Questions

1. 1. What is antitrust policy and why is it important? What does the often used phrase “antitrust concerns” mean?
2. 2. In analyzing whether the purchase of Rite Aid stores would result in anticompetitive practices, the FTC examined Walgreens’ regional market share before and after the sale of Rite Aid’s stores. What factors other than market share should be considered in determining whether a potential transaction might result in anticompetitive practices?
3. 3. What are the risks to Walgreens and Rite Aid of delaying the closing date? Be specific.
4. 4. Who do you think are the winners and the losers in this deal? Consider all constituents including shareholders, consumers, suppliers, lenders, and regulators.

Solutions to these case study questions are found in the Online Instructor’s Manual available to instructors using this book (https://textbooks.elsevier.com/web/product_details.aspx?isbn=9780128150757).