The Importance of the Counterfactual in Merger Assessment - Essay Example

?Competition Law: A Critique on Counterfactual Assessments Concentrations1—ordinarily referred to as mergers and/or acquisitions—are strategies employed by business entities to combine resources to streamline their operations, to expand their reach in the market or simply to corner trade opportunities. Mergers and acquisitions have prominently figured in the recent past due to the failing global economies. Mergers were viewed as safety measures implemented by business entities of equal capital or assets to strengthen its holdings and enhance its profitability while smaller competitors are taken over or defeated by its competitors through hostile or friendly acquisitions. However, not all mergers and acquisitions have been allowed to prosper particularly if it is found to prevent, restrict and distort competition and more importantly, if it would create or strengthen dominant position. Mergers or acquisitions are therefore assessed if it would significantly impede effective competition for being anti-competitive or strengthens dominance—thus an inquiry shall be made by the competition authorities to determine its impact on the market whether competition is still functioning effectively despite the merger or acquisition and the same is beneficial to the public in general. Competition laws to regulate merger and/or acquisition activities were legislated amongst the Member States of the European Union2 while Member States were mandated to enact national competition laws3 to synchronize the procedures to be followed in determining the validity of the merger and/or acquisition as well as to evaluate if the mergers and/or acquisitions are in accordance with the competition standards that encourage healthy competition and more importantly, do not significantly lessen competition. Nonetheless, the steady increase in the number of mergers and/or acquisitions amongst companies resulted in the enactment of more stringent merger control laws to protect the general public from capitalistic adventurism and abuse. Standards and procedures in determining whether the merger or acquisition is within the realm of the competition laws were modified and innovative assessment systems were introduced to include not only counterfactuals but scrutinizes the economic viability and practicability of the mergers and acquisitions as well. The primary task of this paper is to determine whether it is necessary for the competition authorities in the conduct of its investigation to allow or reject merger and/or acquisition to make assumptions and go beyond the facts and circumstances submitted by the merging entities to determine whether market competition is in force? It shall likewise be the task of this paper to determine the feasibility of making the hypothesis and the resulting conclusion as basis for sustaining or rejecting mergers or acquisitions? Furthermore, it shall be the task of this paper to determine if counterfactuals are indeed imperative to adjudge if a merger or acquisition significantly lessens competition (SLC) or not? And lastly, to determine whether the use of hypothesis or counterfactual circumstances to support an anti-competitive finding is congruent with the general legal precepts that decisions should be based on actual facts availing and as supported by evidence. Before this paper shall tackle the import of counterfactuals in resolving competition issues, it is necessary to revisit the historical and legal perspective of competition edicts including the jurisprudential pronouncements of both the European Courts of Justice (ECJ) and the national courts so that the spirit and letter of these legislations may be understood and applied properly in arriving at a logical conclusion—whether it is indeed beneficial or futile in competition analysis. State intervention on matters relating to the conduct of business is not a new concept. Under this jurisdiction, the general rule is that freedom to trade or conduct business cannot be curtailed or restrained unless the transaction is fraught with unreasonable conditions or contrary to law and public policy. This principle is best illustrated in the case of Nordenfelt v. Maxim Nordenfelt Guns and Ammunition Co Ltd [1894] AC 5354 where the provision of the agreement proscribing the free trade or competition was nullified while the other provisions found just and reasonable were sustained and put into effect under the striking out test.5 However, the common law principle applied by the United Kingdom in assessing whether business transactions are restrictive of trade was superseded when the United Kingdom joined the European Community in 1972. By virtue of the European Communities Act 1972,6 the United Kingdom integrated the European Community laws into its domestic laws recognizing free movement of goods, capital, services, persons and establishments as its fundamental guiding principles. And, more importantly, by its accession, the United Kingdom is now mandated to apply and enforce, among others, the EC Competition Law7 in determining whether unfair business practices or disruptive competition activities are happening within its jurisdiction. EU competition law was conceived as European Coal and Steel Community (ECSC) in 19518 to maintain the peace and more specifically, to prevent Germany from re-establishing dominance in the production of coal and steel as its perceived dominance was contributory to the outbreak of the war. Pursuant to this undertaking, mergers, concentrations, cartels, and the abuse of a dominant position by companies were explicitly prohibited. The enactment of the Treaty of Rome9 not only established the European Economic Community but it embodied the competition rules as well. Presently, the applicable treaty is the Treaty of Lisbon10 which explicitly prohibits anti-competitive agreements including price fixing11 and any agreement to this effect is without any force and effect.12 Nonetheless, the provisions of the Treaty of Lisbon is not absolute and admit exemptions13 if the objective is for distributional or technological innovation, provided that the consumers are accorded a fair share of the benefit but it should not impose unreasonable restraints that risk eliminating competition. The Treaty likewise explicitly prohibits abuse of position by exclusive dealing and price discrimination14 where the European Council is tasked to regulate mergers between firms15 as enunciated in Regulation 139/2004/EC16 where the general test to verify whether a concentration such as merger or acquisition with a community dimension which affects a number of EU member states might significantly impede effective competition. Merger Regulation 139/2004 signalled the paradigm shift of the European Commission from the strict application of the law based on the factual submission as basis for determining the validity of concentration—merger or acquisition—it has introduced the use of economic analysis as the core consideration to decide competition issues. This is in contrasts with the old policy that concentrations17—mergers and acquisitions—shall be appraised whether they are compatible with the common market where it shall take into consideration the need to preserve and develop effective competition within the common market institutionalizing a system of ensuring that competition in the common market is not distorted18 Furthermore, it shall evaluate the market outcome of the undertakings concerned and their economic and financial power, the opportunities available to suppliers and users, their access to supplies or markets, any legal or other barriers to entry, supply and demand trends for the relevant goods and services, the interests of the intermediate and ultimate consumers, and the development of technical and economic progress provided that it is to consumers' advantage and does not form an obstacle to competition.19 Thus, under the old policy, when a concentration does not create or strengthen a dominant position which would significantly impede effective competition (SEIC) in the common market or in a substantial part of it shall be declared compatible with the common market20. Stated differently, if a concentration creates or strengthens a dominant position which would significantly impede effective competition in the common market or in a substantial part of it then the same shall be declared incompatible with the common market.21 Competition is deemed effective if it produces benefits to consumers which include but not limited to low prices, high-quality products, a wide selection of goods and services, and innovation. The guidelines on the assessment of horizontal mergers22 prevent mergers that would allow or bestow favour upon one entity to flood the market of its products for its own benefit or profit to the detriment of the customers. It could be gleaned that the objective of the law is to ensure that healthy competition prevail to guarantee that the customers are not unduly deprived of market benefits by restricting or controlling the available products in the market. The competition law, by its very nature, promotes consumer welfare as its protective arms prohibit any merger which is detrimental to public interest and welfare. Thus, the competition authorities have crafted rules and procedures which would promote greater efficiency towards determining market concentration or monopoly. The prior approval from the Commission would guarantee that the merger or acquisition is beneficial to the public hence the Commission must be notified of the concluded transaction to assess if the proponents are actual or potential competitors on the same relevant market—this is referred to as horizontal merger. As a general rule, horizontal mergers are frowned upon not only as it is intended to eliminate effective competition from the market but more importantly, it cannot be disputed that the market power of the merged establishment will be greater than the market power of either of the parties prior to merger and operating independently. Nonetheless, the notice requirement is pertinent to mergers or acquisitions that significantly reduce competition on the relevant market or facilitates collusion between the merged entities to the damage and prejudice of the consumers. While the Commission is likely to intervene when the merger does not produce on the market levels of concentration exceeding certain levels indicated by market-share percentage or by the Herfindahl-Hirschmann Index (HHI)23 which is calculated based on market shares of all the firms in the market that gives proportionately greater weight to the market shares of larger firms. Although the absolute level of the HHI will show the competitive pressure in the market after the merger, it is the change in the HHI that is a useful indication for the change in concentration which is brought about by the merger. In assessing the competitive effects of a merger, the Commission compares the competitive conditions that would result from the notified merger with the conditions that would have prevailed without the merger.24 In most cases the competitive conditions existing at the time of the merger constitute the relevant comparison for evaluating the effects of a merger. However, in some circumstances, the Commission may take into account future changes to the market that can reasonably be predicted25. It may, in particular, take account of the likely entry or exit of firms if the merger did not take place when considering what constitutes the relevant comparison.26 Thus, the introduction of counterfactual assessments became necessary which is a departure from a form-based approach27 to an effects-based approach28. Counterfactual analysis may be used in two forms; (1) Counterfactual analysis is used to assess whether proposed mergers and acquisitions have the probability of 'substantially' lessening competition in the market systems.29 (2) This method of investigating the mergers and acquisitions may likewise be used to assess whether a firm with substantial market power has taken advantage of its power. This is determined if they have done something that they would not be capable of doing in a competitive market.30 This is therefore assessed through a counterfactual. Culled from the foregoing counterfactual forms, the primordial concern of the counterfactual assessments is to ascertain the effects of a given merger or acquisition which is not given weight under the form-based approach. The effects-approached was first presented in the early case of Societe Technique Miniere31 where it was ruled that the agreement containing a clause “granting exclusive right of sale” does not automatically avoid the transaction—its main objective must be to prevent, restrict or distort competition.32 The shift to effects-based approach is more consistent with the policy that competition protects the rights of the consumers—this would not be achievable if the form-based approach is maintained as this technique is perceived to promote the interest of the establishments. Stiff competition is therefore essential to give the consumers variety choices—good quality but at affordable prices. It would similarly entail establishments to be more efficient in their operations to compete in the market. The effects-based approach significantly reduces the probability for merging entities to contrive a plan to skirt compliance as they are mandated to perform self-assessment to determine whether the agreement restricts competition by its object. And, when the purpose of the agreement is found to promote competition then the merging parties shall determine the effects of the merger using the counterfactual method and submit a comparative study showing the effects of the merged market vis-a-vis a merger-less market. The burden is upon the parties to show that the merger promotes competition or even if it is perceived to be anti-competitive, it must be cleared for merger as its combined resources would redound to the benefit of the consumers. In a perfect competition is an economic theory wherein firms that equally do not have a control in the market to set the price of homogenous products.33 Firms that operate under a competitive market delivers new goods and services that would give consumers better options and better commodities. It is through this system that consumers obtain lower prices in contrast when there is monopoly and oligopoly wherein firms are price makers resulting to high prices and higher profit. The main goal of authorities for the firms to undergo counterfactual assessments is to prevent the companies from obtaining large market shares that would result to a monopoly or an oligopoly. Counterfactual analysis has become an integral part of market systems34 as it helps in assessing and forecasting the probable effects of mergers and acquisitions. As earlier stated, a counterfactual assessment provides two assessments of a situation –with and without analysis of the merger. This would provide an objective analysis if there would be a substantial lessening of competition (SLC) if there is a merger and if the market can do without the merger.35 It is first and foremost an analytical tool. It answers a series of what if questions that assumes variables and situation that may affect firms and market forces; typically, authorities that facilitate the research and investigations makes us of facts about of the company and in the market in order to make it the results more probable and sound. One of the examples set out by Alistair Lindsay in July 2011 in the article entitled, UK Merger Control: Recent Developments was the acquisition of Ratcliff Palfinger of Ross & Bonnyman. In this transaction RP bought R&B's business of supplying spare parts for commercial vehicle tail lifts. The facts that were laid out by both parties are: R&B would continue to supply tail lifts despite the acquisitions and that R&B did not need to wind down its tail lift manufacturing business in order to facilitate the sale. The transaction was cleared as it was not necessary for them to tone down their manufacturing business to sell spare parts. After the merger, the Commission is nonetheless not helpless to strike down the transaction—counterfactual analysis can be utilized to show that the transaction is anti-competitive by comparing prices that prevail on the relevant market with prices on a comparable product/geographic market that is not affected by the agreement. Other tools or techniques may likewise be used such as but not limited to regression analysis to control for exogenous factors, simulate counterfactual market outcomes on the basis of models—from monopoly to perfect competition or the cost-based method—estimates the level of prices under the merged situation and without. The effects-based approach is equally applied to the determination of abuse of dominance. In the Sot. Lelos kai Sia EE et.al. v. GlaxoSmithKline36, it was ruled that an undertaking occupying a dominant position on the relevant market for medicinal products which, in order to put a stop to parallel exports carried out by certain wholesalers from one Member State to other Member States, refuses to meet ordinary orders from those wholesalers is abusing its dominant position. The ECJ further ruled that is for the national court to ascertain whether the orders are ordinary in the light of both the size of those orders in relation to the requirements of the market in the first Member State and the previous business relations between that undertaking and the wholesalers concerned. From above-cited case, the analysis used in abuse of dominant position is comparative study of the market impact of restriction of the parallel importation. It did not automatically shot down the restriction of parallel importation of medicines but it required proof that it would indeed result in abuse of dominance. The ECJ initiated an investigation against Rambus37 following allegations that it engaged in a “patent ambush”38 when it participated in a US industry standard-setting organisation, the Joint Electron Devices Engineering Council (JEDEC). It was posited that Rambus intentionally concealed the fact that it had patents and patent applications which were relevant to technology used in the JEDEC standard, subsequently claiming high royalties for those patents. However, the Commission's concerns were alleviated when Rambus committed to put a worldwide cap on its royalty rates for products compliant with the JEDEC standards for the next five years. The settlement led to the closure of the Commission's case but it cautioned that patent holders need to be open and honest as to what they intend to do prior to adoption of their technology into a standard.39 A dominant position does not automatically entail abuse unless it shown that it harms the other entities. If abuse of dominance is established then the aggrieved party may litigate and seek restitution by way of damages.40 The United Kingdom uses the substantially lessening of competition (SLC)41 as yardstick for determining whether the concentration is anti-competitive, including theories of harms and counterfactuals. The Office of Fair Trading (OFT) examines the prevailing conditions of competition (or the pre-merger situation in the case of completed mergers) as the counterfactual against which to assess the impact of the merger.42 On the other hand, the Competition Commission does not confine its examination on a single event but rather it considers several and chooses one situation as the counterfactual43 which may be exiting firm scenario44 loss of potential entrant scenario45; and competing bids and parallel transactions.46 Conclusion The use of counterfactual analysis is appropriate and proper to promote the general welfare of the public. Mergers and acquisition in order to be deemed beneficial to the general public must promote a healthy competition and that the merger would result to better products and a more competitive price for the consumers. However, these benefits can only be known if the actual mergers and acquisition have taken place or have been tested and verified through the actual operation of the merged organization. To prevent entities from exerting undue advantage over its competitors, counterfactual analysis is a necessary tool to eliminate anticompetitive acts. To successfully implement an objective analysis, the only other alternative is to develop an economic model involving the parties-in-interest in the applications for mergers and acquisitions. The model would indicate the possible impact of the mergers to the consumers and to the economy at large. An economic laboratory that could be used to create the economic model is only possible through numerical analysis. Counterfactual analysis seeks to establish the effects of a given transaction, agreement or conduct of organizations seeking to merge or acquire another organization. It is the mathematical representation and analysis of the possible impacts of mergers and acquisitions. It contemplates scenarios prior and post-merger—speculative but nonetheless based on economic or mathematical estimation coupled with the factual submission of the parties concerned are sufficient basis to ascertain that the merger comes within the purview of competition laws, regulations and jurisprudence. Bibliography 1. Council Regulation (EC) No 139/2004 of 20 January 2004 on the control of concentrations between undertakings 2. Guidelines on the assessment of horizontal mergers under the Council Regulation on the control of concentrations between undertakings (2004/C 31/03) 98/526/EC in Case IV/M.950 - Hoffmann La Roche/Boehringer Mannheim, Official Journal L 234 , 21/08/1998 P. 0014 – 0038 http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:31998D0526:EN:HTML 3. [1894] AC 535. Nordenfelt v. Maxim Nordenfelt Guns and Ammunition Co Ltd http://www.uniset.ca/other/cs6/1894AC535.html (retrieved- 04 December 2011) 4. Parliament of the United Kingdom. European Communities Act 192. http://www.legislation.gov.uk/ukpga/1972/68/contents 5. European Union. Council Regulation (EEC) No. 4064/89. http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:31989R4064:EN:NOT 6. European Union. Guidelines on the assessment of horizontal mergers under the Council Regulation on the control of concentrations between undertakings (2004/C 31/03) http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:52004XC0205(02):EN:NOT 7. European Union. Commission Notice on the definition of relevant market for the purposes of Community competition law (97/C 372/03) http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:31997Y1209(01):EN:NOT 8. Case No. COMP/M.5529. ORACLE/ SUN MICROSYSTEMS http://ec.europa.eu/competition/mergers/cases/decisions/m5529_20100121_20682_en.pdf 9. Case No COMP/M.2876. NEWSCORP/ TELEPIUi http://ec.europa.eu/competition/mergers/cases/decisions/m2876_en.pdf 10. Case T?342/07, Ryanair Holdings plc v. European Commission http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:62007A0342:EN:HTML 11. Lindsay, A. (2011) UK Merger Control: Recent Developments. Monckton Chamber. p. 2 (retrieved on 04 December 2011 at http://www.monckton.com/docs/library/UKMERGERCONTROLJULY2011.pdf) 12. Geradin, D. & Girgenson, I. (2011). The Counterfactual Method in EU Competition Law: The Cornerstone of the Effects-Based Approach. (retrieved on 04 December 2011 at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1970917) 13. Roller, Lars-Hendrik & de la Mano, Miguel. (2006) The Impact of the New Substantive Test in European Merger Control. (retrieved on 04 December 2011 at http://ec.europa.eu/dgs/competition/economist/new_substantive_test.pdf) 14. Davis, P. & Cooper, A. (2010) On the Use of Counterfactuals in Merger Inquiries. (retrieved on 04 December 2011 at http://www.competition-commission.org.uk/our_role/analysis/10_05_20_Counterfactual_long_paper_v2_1.pdf) 15. Competition Commission. (2010) Merger Assessment Guidelines. (retrieved on 04 December 2011 at http://www.oft.gov.uk/shared_oft/mergers/642749/OFT1254.pdf) 16. Land, J. & Swan, K. (2010) Counterfactual Analysis Under the Commerce Act: Paper for the Competition Law and Policy Institute of New Zealand Workshop. (retrieved on 04 December 2011 at http://www.kensingtonswan.com/Newsletters/Competition%20and%20Consumer/Counterfactual_Analysis.pdf) 17. European Union. (2010) Consolidated Version of the Treaty on the Functioning of the European Union. 30 March 2010. (retrieved on 04 December 2011 at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2010:083:0047:0200:en:PDF) 18. Case C?209/07 Beef Industry Development Society and Barry Brothers [2008] ECR I?8637. 19. European Union. Treaty of Lisbon. 13 December 2007. (retrieved on 18 December 2011 at http://www.consilium.europa.eu/treaty-of-lisbon.aspx?lang=en) 20. European Union. European Communities Act 1972 21. Land, J. & Swan, K. Paper for the Competition law and Policy institute of New Zealand Workshop. Wellington 2010 p.2) 22. Stabile, Donald R.. Economics, Competition and Academia: An Intellectual History of Sophism versus Virtue. Edward Elgar Publishing, Inc. Northampton, 2007. 23. JoinedCases C-468/06 to C-478/06. (retrieved on 04 December 2011 at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:62006CC0468:EN:NOT 24. Tricker, M. (2010) Belgium: EU Antitrust Briefing: A Standard Year For The European Commission. (retrieved on 18 December 2011 at http://www.mondaq.com/article.asp?articleid=94956) 25. C-453/99. Courage v. Crehan 20 September 2001. (retrieved on 18 December 2011 at http://eur-lex.europa.eu/smartapi/cgi/sga_doc?smartapi!celexplus!prod!CELEXnumdoc&lg=en&numdoc=61999J0453 Read More