Is Divestiture a Viable Antitrust Remedy?
September 29, 2017
Divestiture. It is a word anyone who follows mega-mergers and antitrust law hears on almost a daily basis. The first time that I thought about it was in a course I took, “Economic Analysis of Law” and the idea did not make too much sense. When companies merge aren’t they planning on creating some sort of new efficiency by becoming a larger company? Wouldn’t they be giving up any economies of scale by unloading a sizable chunk of their companies? That’s why when I stumbled across a New York Times article with some anecdotal evidence that supported my skepticism [Sagers, “Limits of Divestiture”], I wanted to delve deeper into the issue. During my summer at the FTC, I have been involved on a case that analyzed a divestiture remedy and I have been able to read some FTC resources to better verse myself on the subject.
By Nic Urban
Whenever companies engage in a merger that is worth more than $323 million at the time of closing, they are required to report it to the Federal Trade Commission (FTC) by the Hart Scott Rodino Antitrust Improvements Act of 1976 (HSR). The US Department of Justice (DOJ) or the FTC will then review the deal against their Horizontal Merger Guidelines in order to determine whether the merger will cause the competition in the product market, which the FTC or DOJ attempts to define, to diminish severely enough that a small but significant price increase would be viable for the new entity. In other words, they try to answer the question: could the new entity achieve monopolist rents? If the government entity, after researching the deal and the market finds the deal to be concerning, they will continue to investigate and build a case against the merger until an official vote by the commissioners either approves or denies their recommendation to attempt to win an injunction against the merger in court. One way that companies can avoid this litigation is to offer up a remedy, which, in most cases is divestiture.
What is Divestiture?
Divestiture, as an antitrust remedy, is the concept that when two companies are combining, if they sell off a certain amount of their assets to a third company, the third company can become a competitor that replaces the lost competition from the merger. This, in theory, alleviates the interests of both the government and the companies since they would then be given clearance to merge while maintaining competition.
Not all divestitures look the same, however. For example, in the case of the Dow Chemical and DuPont merger, they gained antitrust approval by selling certain insecticides and herbicides in order to maintain competition in extremely specific herbicide and insecticide markets that only they compete in pre-merger [Bartz, “Dow, DuPont”]. However, when the merger is between companies who have actual stores, the divestiture usually involves one of the companies selling a certain number of store locations to a different company in an attempt to maintain competition.
Does it Work?
The first level of opposition to divestiture would be that the merging companies would be missing some benefits of being a larger company by giving up part of their company. I believe that this opposition can be dismissed, however, since efficiencies is one thing that the FTC and DOJ try to understand during investigation. Efficiencies can also be used as a defense by the parties were the merger to be litigated, so if the companies believed that they needed a full scale merger to achieve some sort of efficiencies (for example, economies of scale) they wouldn’t be likely to settle on a divestiture that would ruin their advantage.
After getting over that hurdle of opposition then, the idea seems to make economic sense. It does not matter where the competition is coming from as long as there is competition, right? Unfortunately, it’s not that simple, especially when dealing with deals with store divestiture. The success of the third party receiving the divested stores, and therefore the strength of competition depends largely on the management and marketing of the company, not just the number of stores. If tomorrow we decided to give the local diner 500 Denny’s restaurants across the nation, we wouldn’t expect them to compete with IHOP the next day. In fact, we would likely see the overwhelmed management team not know what to do and end up going out of business, especially when considering the amount of cash they lose when buying the stores. The aforementioned New York Times article sees this as an imminent issue as well, and cites several anecdotal examples, including one of a small grocery chain that went bankrupt soon after acquiring enough stores to increase its size by 900 percent in a divestiture that allowed two larger grocery chains to merge.
The FTC actually asked itself whether divestiture was working by conducting and publishing internal studies in 1999 and January of this year [FTC, Study of Commission’s Divestiture Process & FTC, Merger Remedies Study 2006-2012]. In both studies they discuss the fact that a vast majority of companies that received divested assets remain with those companies and that the companies have remained in the markets that they were originally concerned about. They then determined that based on those two aspects that divestiture must be working. After all, if they weren’t providing competition, wouldn’t they have gone bankrupt or stopped that portion of their business? This simple test of the success of divestiture does not take into account the quality of the competition, but does it need to? Seemingly when the FTC conducts their initial investigation into the market, they certainly look at the quality of competition and sometimes narrow markets down so small based on the quality of competition that the merger creates a monopoly. For example, when Staples tried to buy Office Depot, the FTC successfully defined the market as “the sale of consumable office supplies through office superstores,” disqualifying potential competitors like Walmart or Target since they are not “office superstores.” [FTC v. Staples]. So, obviously the FTC cares more than just the existence of another store selling similar products. Nevertheless, the survival of the divested stores does point to divestiture at least mitigating against lost competition.
Furthermore, during my time this summer at the FTC I have had the honor of working on a case where a large portion of the case involved analyzing a proposed recipient of divested assets. The amount of due diligence that the attorneys actually do in order to decide whether or not a buyer of divested assets is strong enough to provide actual competition is impressive. They do not simply take into account the financial position of the company, but also they review business plans, history, and corporate culture to decide whether or not they will be able to succeed in this market. Of course, at the end of the day (if they approve a buyer) the FTC is betting on a company, and will not be correct 100% of the time. The quality of competition from divested assets may not be at the level where all competition is replaced, but as long as the companies remain in the market, divestiture does appear to be a mitigating force. While an intense econometric analysis would likely answer the extent that competition is replaced through divestiture, it currently stands as the only mitigating force against the age of consolidations through horizontal mergers that we appear to be in the midst of.
Bartz, Diane. “Dow, DuPont Merger wins U.S. antitrust approval with conditions.” Reuters. June 15, 2017. Accessed July 15, 2017. http://www.reuters.com/article/us-du-pont-m-a-dow-idUSKBN1962SN
FTC v. Staples, Inc., 970 F. Supp. 1066 (D.D.C. 1997)
Sagers, Chris. “The Limits of Divestiture as an Antitrust Remedy.” The New York Times. February 14, 2017. Accessed July 14, 2017. https://www.nytimes.com/2017/02/14/business/dealbook/the-limits-of-divestiture-as-an-antitrust-remedy.html?_r=0
United States of America. Federal Trade Commission. Bureaus of Competition and Economics. The FTC’s Merger Remedies 2006-2012. By Daniel P. Ducore and Timothy A. Deyak.
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United States of America. Federal Trade Commission. Bureau of Competition. A Study of the Commission’s Divestiture Process. By William J. Bayer.