Is EU Merger Policy Less Stringent After Its 2004 Reform?

Transcription

1 Is EU Merger Policy Less Stringent After Its 2004 Reform? Preliminary results Anh T.V. Mai Department of Social Science, Södertörn University Huddinge, Stockholm, Sweden Mar 2015 Abstract The paper studies how the 2004 merger policy reform affected the probability of a merger being challenged by the European Commission. A probit model is used to assess how economic factors drive decisions and to pin down differences between policies before and after the reform. The net sample consists of 341 horizontal mergers from 1990 to Overall, I find robust evidence of policy shifts due to the reform. By some measures, the policy appears to have softened for unilateral-effects mergers and toughened for coordinated-effects mergers. Market shares and entry barriers are found to influence decisions before as well as after the reform. However, market shares appear to play a somewhat smaller role after the reform. 1

2 1. Introduction A merger may be part of a strategy to enhance a firms competitiveness through more efficient resource allocation. A merger will typically also increase the firm's market power. Hence, consumers may ultimately gain or lose from restructuring. Consequently, merger regulation is an important regulatory tool for competition authorities around the world. The authorities aim to ensure that markets are competitive to benefit consumers. To prevent anti-competitive mergers, proposed transactions are screened and potentially harmful mergers are carefully investigated. To economize on resources, there are typically multiple stages of screens and investigations. The European Commission (EC), one of the two major antitrust regulators of the world, is responsible for investigating mergers under the EU Merger Regulation (ECMR) and its decisions on mergers have considerable impact on global markets. Thus any variation in merger policy will directly influence consumer welfare, firm profit and, indirectly, the firms merger activities. In 2001, the EC prohibited a merger between two US companies, General Electric Company (GE) and Honeywell International Inc., which earlier had been cleared by the US Department of Justice (DoJ) and 11 other jurisdictions. In adopting the decision, the EC concluded that the merger would create dominant positions in the markets for the supply of avionics, non-avionics and corporate jet engines and, in addition, enhance GE's pre-existing dominant position in jet engines for large commercial and large regional jets. In contrast, the DoJ welcomed this merger and predicted that prices would be lower when the merged firm gained market shares. The opposite conclusions showed a divergence between North American and European merger enforcements (Patterson & Shapiro, 2001). Since the GE/Honeywell prohibition, the EC has undertaken significant reforms of their merger policy in term of guidelines and procedures (Garcia & Neven, 2005). The new ECMR, adopted in 2004, introduced a new substantive test as well as significant procedural changes, was portrayed as a significant improvement of the merger-control system and would, according to some scholars, move European merger policy a step closer to the US Merger Enforcement 1. 1 Before the reform, in the area of merger control, the EC was more interventionist or stringent than the US competition authority (Lévêque, 2006). The EC was criticized for acting in the narrow protectionist rather than sound economic reasons (Garcia & Neven, 2005). 2

3 Mergers and merger policy can be approached from various aspects, as evidenced by the huge literature. One strand of the literature has focused on fundamental factors affecting merger decisions in a specific regime (Coate et al., 1990; Khemani & Shapiro, 1993; Bergman et al., 2005; Coate, 2005; Duso, Gugler, & Yurtoglu, 2011). Some recent papers have compared the merger enforcement in the EU and the US, the two dominant regimes in the world (Bergman et al., 2010; Szücs, 2012). While EU's 2004 reform has been studied previously, so far most economic research on the EU reform has been primarily theoretical and focused on the jurisdictional and procedural issues (Berg, 2004; Lyons, 2004; Röller, 2006a; Monti, 2008; Barrientos, 2007; Gecić & Bogdan, 2010). Overall, they concluded that the procedural amendments are the most positive significant change 2. The changes in the new substantive test under which mergers are reviewed need to be assessed in a long-term perspective. The diversity of earlier theoretical models highlights the need for empirical research. The amount of empirical papers assessing the policy before and after the reform is growing, but it is still rather small (Fernández, et al., 2008; Duso, et al., 2013). Therefore, it is interesting and important to use reliable and updated data to analyze how EU merger policy changed after the reform. In this study, the net sample consists of 341 horizontal mergers notified to the EC during the 1990 to 2012 period. The data is an extension of the data used in Bergman et al. 3 New observations were added, using the same procedures and coding instructions as were used in that study. Data were directly extracted from the written reports of the EC. The aim of this paper is to compare the EU merger control before and after the reform 2004, based on the predicted probability of challenge to a merger. First, probit models are applied to estimate parametrically the impact of the reform on the likelihood of the merger being challenged. Second, to compare the pre- and post-merger policies, I use the models to predict how the EC would have made their decision, had the old policy been in force for the mergers that occurred after 2004 and, 2 The Commission has introduced a number of improvements in its own organization and procedures, such as a creation of the office of the Chief Economist; more flexible deadlines, etc 3 Available at The existing dataset included a sample of the EU and the US merger notifications from 1990 to The final EU dataset contained 109 horizontal mergers in the Phase 2 investigations. In this paper, both Phase 1 and Phase 2 investigations are scrutinized in an extended period,

4 conversely, had the new policy been in force already before These hypotheticals are then compared to actual challenge rates. There are three main findings. First, in line with many previous papers, the merging parties' combined market share as well as evidences of entry barriers play important roles in explaining the EC s decisions. Second, the new merger policy seems to take a more tolerant view on unilateral-effects mergers. Conversely, the EC is more stringent when assessing coordinatedeffects mergers after than before the reform. Finally, no significant impact of political variables on the probability of a challenge is found. This last finding is a positive indication of a transparent and unbiased process. The rest of the paper is organized as follows. Section 2 provides an overview of the merger regulation, with an emphasis on the 2004 policy reform. Section 3 presents the previous literature and Section 4 describes the data set. Section 5 introduces the model specifications. Section 6 shows results from the regressions, and a comparison of the two policies is reported in Section 7. Section 8 shows some robustness checks. The conclusion is written in Section Background 2.1 Why Does the European Commission Regulate Mergers? Making markets work better (European Commission, 2013) Regulation of competition has been undertaken by the European Commission (EC) since Under the competition law, four primary activities of the DG Competition at the EC are antitrust, mergers, state aid, and liberalization. The aim of the DG Competition is to ensure that the EU market works better for all EU citizens. Merger regulation has become an ever more important area of the EC s enforcement because the trend of mergers was constantly positive in the 1990s. Even though there were subsequently a sharp decrease in early 2000s and then again in (Figure 1), the sums of money invested in the mergers have broken the all-time records almost every year (Weber, 2013). However, while some combinations bring benefits to the economy, some may reduce competition. Some mergers may allow the merging firms to produce more efficiently by reducing production or distribution costs, and thus the market becomes more competitive and consumers can benefit 4

5 through high-quality goods at lower prices. However, some mergers may create or increase market power and may give the merging parties a dominant position. When market power is enhanced, competition is likely to suffer and consumers may get lower-quality goods, higher prices, reduced choice or less innovation (Davies & Lyons, 2008). Under the merger laws, the EC has the power to prohibit mergers that threaten the competition. 2.2 EU Merger Regulation (ECMR) A mechanism for the control of mergers at the EU level was provided in the ECRM. The principal legislative text of the ECMR consists of two parts, the regulation and the implementing regulation. The assessment rules of merger concentrations are introduced in the regulation while procedural rules are described in the implementing regulation. The first ECMR No. 4064/89 (hereafter ECMR89) was entered into force in The new ECMR No. 139/2004 (hereafter ECMR04) was adopted on May 1, The ECMR04 introduced a revised package, which was expected to strengthen the functioning of the merger control and enhance the predictability and transparency of the EC s decisions on mergers. According to the EC s Green Paper on the merger control review, the key to reform of the implementing regulation was the time needed to process a merger 4. The merger review is given longer time under the ECMR04, allowing the parties more time to prepare their defense 5. A premerger notification could possibly be released before an agreement is concluded, for example a binding letter of intent. Additionally, a Chief Competition Economist role was created. The Chief Competition Economist and his or her team participate in merger investigations and can be temporarily assigned to support the EC. The EC also allocated additional support staff to the hearing officers, intended to ensure the fairness of the EC s decisions. Overall, all amendments were expected to enhance the quality of the merge decision as well as the efficiency of mergers. 4 See 5 ECMR04: After notification, the Commission has 25 working days to analyze the deal during the phase I investigation. From the opening of a Phase II investigation, the Commission has 90 working days to make a final decision on the compatibility of the planned transaction with the EU Merger Regulation. This can be extended by an additional 15 working days if the notifying parties offer commitments later in phase II. ECMR89: The decisions referred to in Article 6 (1) must be taken within one month at most. Without prejudice to Article 8 (6), decisions taken pursuant to Article 8 (3) concerning notified concentrations must be taken within not more than four months of the date on which the proceeding is initiated (Article 10) 5

6 The revised package of the regulation consisted of a separate guideline on how to assess horizontal mergers and a draft guideline for non-horizontal (vertical or conglomerate) mergers 6. The most significant change of the horizontal merger guideline was a new substantive test, which also allowed merging firms an efficiency defense. The new test is further explained in section 2.3. The guidelines are also part of the benchmarks used by the EU Courts when cases are appealed. 2.3 "Significantly Impede Effective Competition vs Dominance Test Prior to 1 May 2004, the Dominance Test (DT) was applicable. The major revision in the guideline was the new substantive test, the so-called "Significantly Impede Effective Competition (SIEC) test. The new test is considered to be similarly to the Substantial Lessening of Competition (SLC) test applied in others jurisdictions, including the US. Therefore the adoption of the SIEC test is said to be a step towards the US merger control. However, the new test had caused a lot of controversy and intensive debates during its review process (Röller, 2006a). Under article 2(3) ECMR89, mergers that create or strengthen a dominant position as a result of which effective competition would be significantly impeded were prohibited. Mergers that created or enhanced dominance were automatically assumed to impede effective competition. The previous regulation was seem to put too much emphasis on finding evidence of dominance. Without evidence of dominance, the merger would not be challenged. The text of article 2(3) ECMR04 states that a concentration which would significantly impede effective competition in the common market or in a substantial part of it, in particular as a result of the creation or strengthening of a dominant position, shall be declared incompatible with the common market. Unlike the DT, which focuses only on the structure of the market, the SIEC test pays more attention to the competitive effects of mergers on competitors, and consumers. A merger may be cleared even if dominance is created or strengthened in the market if the merger can also be shown to introduce significant efficiency gains. This is called an efficiency defense. A notable example of an efficiency defense is when the EC cleared the merger between P&G and Gillette, two leading 6 See Official Journal of the European Union, C 31, 5 Feb 2004 for the guideline on the assessment of horizontal mergers. See Official Journal of the European Union, C 265, 18 Oct 2008 for the guideline on the assessment of non-horizontal mergers. 6

7 global producers of consumer goods, subject to conditions 7. The EC stated that enlarging the product portfolio might bring efficiencies to retailers and customers, for example benefits from having only one partner to negotiate with (.one-stop-shop.), suppliers having stronger innovation capacities, and economies of scale and scope. A concern here is whether the SIEC test is better than the DT. Following Lyons (2004), the DT can lead to both type I and type II errors. A type I error occurs if a merger is prohibited that should have been cleared. If one firm is already dominant in the market, its merger with another firms could enhance the market power. The merger would be wrongly intervened even if it brings efficiency gains. In this case, dominance is not sufficient. A type II error occurs if a merger is cleared that should have been prohibited. For an example, when indications of dominance are not clear, the EC would allow the merger without any conditions, even if it may have serious negative competitive effects on consumers. In this case, dominance is not necessary. Mergers are different depending on the nature of the product markets and geographical markets in which the firms operate. Both the DT and the SIEC test take into account market definition, market shares, and other factors leading to anti-competitive effects such as when there are high barriers for future rivals to enter to the market or when consumers do not have bargaining power to prevent high prices, or switch to alternative suppliers, etc. However, there still remained a gap between two tests. The critical change under the SIEC test is the need to establish dominance. While the DT requires that dominance is established, under the SIEC test, dominance is neither necessary nor sufficient. In 2000, the Federal Trade Commission (FTC) blocked a merger between Beech-Nut and Heinz, the second and the third largest baby food producers in the US. The merger would create a firm with a percent market share which, however, would still have a distance to Geber, which was dominant with percent of the market. While Geber had the first position on the shelf for baby food brands at most retailer, as the market leader, Beech-Nut and Heinz had to compete for the second position. The merger would create a duopoly in the baby food market. The FTC predicted that the retail prices would be raised by eliminating distribution competition between Heinz and Beech-Nut. The FTC s decision was based on competitive effects from the transaction. 7 Case no. M

8 The EC would likely not have been able to challenge this merger under the old test because of the absence of clear indications of dominance. The SIEC test is believed to be a more appropriate method to fill the gap of the DT as well as to result convergence to the SLC test. However, it is still obvious that a finding of dominance remains the fundamental factor for the EC to make their decisions in the majority of cases. In practice, market shares are usually the starting point when assessing dominance. 2.4 EU Merger Procedure A merger falling within the EU merger rules will be investigated following a set procedure. The early investigation is called Phase 1 and the subsequent deeper investigation is referred as Phase 2. All mergers must go through Phase 1 in which the EC has at least 25 days to analyze the case after receiving the notification. Almost 88 percent of merger cases are unconditionally cleared at the end of the Phase 1. The remaining 12 percent of the cases reach one of two main conclusions: (1) a merger is cleared subject to accepted remedies; or (2) a merger still raises serious concerns and the EC opens a deeper investigation. Phase 2 investigation is allowed at least 90 working days. During Phase 2, more extensive information is requested, such as the merging firms' internal documents. Besides, the EC can collect more economic data, send questionnaires to market participants, and/or make site visits before issuing a final report of the merger. At the end of Phase 2, the merger may be (1) unconditionally cleared; or (2) approved subject to remedies; or (3) prohibited. Mergers can be reviewed under a simplified procedure 8. Firms are allowed to submit a shorter notification form, and provide less detailed information when notifying mergers that are unlikely to raise any competitive effects, then the mergers are cleared without any investigations. The simplified procedure has also substantially reduced the amount of required information when firms notify regular mergers. All mergers are investigated to see whether they would reduce effective competition in the EU market. If not, the EC will approve the mergers unconditionally. If they do and the merging firms 8 There are thresholds for cases qualifying for simplified procedure. See 8

9 cannot propose any adequate solutions to remove the serious doubts of the EC, the mergers must be prohibited to protect the market. If the merging firms can make commitments to remove the EC s anti-competitive concerns, the EC will conditionally approve the mergers. The remedies depend on the specific cases. For example, the parties may be required to divest all overlapping business, to license the patents, and/or to commit not to raise prices, etc. 3. Earlier Literature Mergers have been a popular topic in the industrial organization field. There is a large body of theoretical and empirical studies addressing various questions related to mergers such as firms incentives to merge, merger-policy effectiveness etc. In this paper, I introduce some relevant papers in which the authors identified the key factors driving the final merger decisions and examine the merge policy reform in EU. Coate et al. (1990, 1992) investigated the factors affecting the final merger decisions of the FTC by examining 70 horizontal mergers during The key variables increasing the probability of a challenge to the merger were the Herfindahl-Hirschman Index (HHI) 9, entry barriers, collusion effects, and findings that one of the firms was failing. Moreover, they included political variables to measure the effects of politics on the proposed mergers. They concluded that more pressure from politicians caused the FTC to challenge more mergers. The politicians appeared to seek to prevent mergers because they tried to avoid the risk that resources and votes would be reallocated after completion of a merger. Bergman et al. (2005) applied logit models to analyze 96 mergers handled by the EC between 1990 and The authors reported that high entry barriers and market shares increased the likelihood of a prohibition. Moreover, a merger inducing collusive market structure was more likely to be prohibited while no indication of the merging firms nationalities was found to impact on the decisions of the EC. Bergman et al. (2010) provided an econometric method to examine the similarities and differences between the two biggest merger enforcement regimes, the EU and the US. They looked at 9 HHI measures the degree of market concentration depending on the number of firms and their size relative to the market. A rule of thumb: a HHI of 1800 or more is generally considered a highly concentrated market. HHI is one of a tool to evaluate the creation of a monopoly in the market. 9

10 horizontal mergers in Phase 2 during the 1990 to 2004 period, then estimated a model for each regime to evaluate the enforcement policy. Even though each regime faced different cases, the authors still found similar variables and patterns, such as barriers to entry, and dominant positions, affecting the merger decisions. However, the institutional issues seemed to have greater impact on the EC while analytical variables, such as countervailing buyer power, vertical aspects, and anticompetitive evidence were more likely to affect the FTC s decisions. Next, they applied the EU model on the US dataset and vice versa to predict probabilities of mergers being challenged. A decomposition method was also introduced and the final conclusion was that it was impossible to say that one regime is more aggressive than another. In other words, there was no big difference in the policy enforcement in the EU and in the US. The most recent paper was written by Szücs (2012). He measured convergence in the jurisdictional patterns under two regimes, the EU and the US, using 595 merger cases from 1995 to He applied logit models to estimate the probability of merger intervention in both jurisdictions. By using two separated models for EU pre- and post- reform and comparing them to the US model, the results suggested that the 2004 reform of EU merger law constituted a step towards the US system. After the reform in 2004, economic theoretical research on the new EU merger law has primarily focused on understanding the SIEC test and compared it with the previous DT. Lyons (2004) was mostly concerned about the impacts of the merger reform by asking the following question Will the reform improve the economic analysis behind its decisions? He concluded that much of the reform package would increase the effectiveness of merger investigations. In his opinion and by comparing the EU law regime and other big regimes, such as those of the US and the UK, the reform package follows the global trend towards the better application of merger. Röller et al. (2006) studied the new test by reviewing the main reasons why the test was changed and its anticipated impacts. They reviewed recent notified mergers under the ECMR04 and identified the EC s competition concerns. They did not find any evidence of major changes in the new policy to evaluate the competitive effects of mergers. Dominance resulting from horizontal mergers (above 50% post-merger market share) is still a sufficient factor to challenge a merger. The EC also uses other evidences of impediment of effective competition. The authors argued that the DT gave less incentives for mergers in which merging parties can enhance efficiency. 10

11 Duso et.al (2011) used stock-market data from the period to assess the effectiveness of EU merger control. Duso et al., (2013) concentrated more on the effectiveness of the EU merger policy reform. To measure the effectiveness of the EU merger policy across industries, they proposed four dimensions: predictability, decision errors, rent-reversion, and deterrence. For each dimension, they estimated the effects of the reform by adopting a before-and-after approach 10. They also suggested a wide range of explanatory factors to predict the EC s final decisions by applying probit models. In line with many previous studies, several variables play significant roles in determining the odds of a merger intervention. They also found that the ECMR04 is a modest improvement. Overall, the number of empirical studies on the EU merger policy reform since 2004 is relatively small comparing to the number of theoretical papers. Some noteworthy results about the reform are that (1) the SIEC test is believed to be a convergence towards other big regimes policies, such as those of the US and the UK; (2) in terms of effectiveness of controlling mergers, little evidences exists to answer the question whether the new policy is better than the previous one. In this paper, I focus on how the reform impacts the EC s merger decisions. 4. Data 4.1 Population Figure 1 presents the evolution of merger notifications during the period The solid line shows the number of mergers in the population. A total of 5,146 cases were notified to the EC up until December On average 300 mergers are reviewed by the EC each year. Overall, the number of mergers have increased dramatically over the period, especially during the 1990 s. In 2001, the figure reached 335, more than five times the number of mergers in the early years of 1990 s. However, there was a big drop in the early 2000s. After the 2004 reform, the number of notifications has risen again to reach a peak of 402 cases in The subsequent decrease can be explained by the economic slowdown. 10 If the reform was successful in making merger policy more effective, we would expect (1) an increase in the predictability of the merger control outcome (legal certainty), (2) a reduction in the frequency of mistakes (decision errors), (3) a larger degree of rent-reversion achieved by remedies, and finally, (4) a higher degree of deterrence of anti-competitive mergers (Duso, Gugler, & Szücs, 2013) 11 See at 11

12 Approximately 88 percent of notified mergers are found to be compatible with the merger regulations and cleared in the Phase 1. The remaining 12 percent of the transactions, approved with remedies or required to move to a deeper investigation, are perhaps more interesting to study. Only a small number of mergers are prohibited by the EC over the period, less than 1 percent of all notifications. 4.2 Sample Restrictions For this paper, data is directly extracted from the EC s written reports. The reports are available and freely accessible through the EC s official website 12. A total of 401 merger decisions during the period of 1990 and 2012 were collected. The data is an extension of the dataset of Bergman et al. (2010). The sample consists of horizontal, vertical and conglomerate mergers cleared with or without conditions in Phase 1, or subjected to a Phase 2 investigation, or withdrawn more than one month in Phase 1 or in Phase 2. From the initial sample, I drop 31 notified mergers whose reports are not available in English. In addition, 29 cases that are concerned with vertical and conglomerate mergers are eliminated. I focus on analyzing a total of 341 horizontal mergers: 196 cases before the reform and 145 cases after the reform. The dotted line in Figure 1 shows the total number of notifications, by decision year in the sample. Even though compared to the total population, the number of mergers in the sample is much smaller, the sample includes most cases cleared with remedies in Phase 1 or transferred to Phase 2. In Figure 2, Panel A reports the numbers of Phase 1 mergers with remedies and Phase 2 mergers while Panel B shows only the number of Phase 2 cases. Overall, there are similar trends of the number of mergers in the population and the sample. The number of mergers shows an increasing trend until the early 2000 s. Figures 3a, 3b and 3c illustrate the proportion of decisions by type, by phase and by decision. The mergers with remedies in both Phase 1 and Phase 2 (type 6(1)b+6(2) and 8(2)) are the majority of the concentrations (72 percent) because they contain full information of all variables in the empirical analysis. A second large proportion of mergers, 14 percent, is compatible mergers (type 6(1)(b) and 8(1)) while the aborted or withdrawn cases (type ab) noticeably account for only 8.2 percent of the sample

13 Figure 3b shows a balance in proportion between Phase 1 and Phase 2 in the sample. Lastly, from Figure 3c, more than two-thirds of the mergers in the sample are challenged by the EC (around 77 percent) Variables The written reports of the mergers are structured by the following sections: (1) merging parties activities and operations; (2) community dimension; (3) competitive assessment(s) of relevant product(s) and market(s); (4) proposed remedies if needed; (5) assessment of proposed remedies; (6) restrictions and (7) conclusion 14. The coding for new observations is consistent with the one in Bergman et al. (2010). In this section, I describe the main variables used in the empirical analysis. The dependent variable, Challenge, is a binary variable representing the EC s decision. Challenge is set to 1 if a merger significantly harms competition in the market. Merger is considered to be challenged if the EC s final decision falls into either three conditions: (1) merger that is prohibited, (2) merger that is conditionally approved after the parties offered the significant remedies package 15, and (3) merger that is withdrawn more than 1 month into Phase 1 or into Phase 2 investigation. Otherwise, Challenge is 0 if the merger is cleared unconditionally or conditionally approved with minor remedies. I use independent variables introduced in Bergman et al. (2010) and Szucs (2011). The independent variables are categorized into four groups: (1) Key variables: Reform, Entryindex or Entrybarriers, PostMS, Share2, Vertical, Evidence and Phase_2 (2) Theory of harm variable: CoordEff (3) Market variables: National, EUorUS, and Worldwide (4) Political variables: IntraUS, IntraEU, Crossborder, USdummy, and EUdummy 13 See the following section for an explanation of the challenge concept. 14 For example: Case M More specifically, we defined two different challenge in the coding guideline. There are narrow-challenge and widechallenge. The narrow-challenge is coded as one if the overlap of problematic product in problematic market is sold off more than 80 percent, it may still be a sufficient asset for a new player to enter the market and compete with the rivals. While the widechallenge equals to one if less than 80 percent of the overlap is sold off, it may still be a sufficient asset for a new player to enter the market and compete with the rivals. In this paper, I use the measure of wide-challenge as the dependent variable (challenge). 13

14 The definitions of the explanatory variables and the expected signs of the coefficients are summarized in Table 1. The key structural variables are proxy for the EC s competition concerns when assessing a merger. The reform variable is included to observe differences challenge probability between the periods before and after the 2004 reform. All mergers notified to the EC after 1 May 2004 are set to 1. Entry barriers are also emphasized when collecting the data. Entry barriers in a problematic market are measured either by an index (Entryindex) or by an indicator variable (Entrybarriers). A high value of Entryindex indicates more difficulty for new firms into the problematic market. Following Bergman et al., 2010, an entry index is based on information for the timeliness, likelihood, and sufficiency of entry. The index range is from 0 to 3, depending on how many of the three factors are found. Entrybarriers equals 1 when high barriers to entry are directly mentioned in the decision text. I use the entry index in the main regressions. The models including the entry dummy are reported in the Appendix. PostMS is the predicted combined market share of the merging firms after a merger while Share2 is the smaller of the two pre-merger market share. A high PostMS could raise serious concerns about the merger being anticompetitive. Vertical is set to 1 if the text suggests finding of vertical effects in the merger. The expected sign of this indicator is not clear. Together with hot document, finding of complaints from customers creates the Evidence index. Hot documents are defined as documents found at the premises of the parties or submitted by the parties that state or suggest that the merger will result in substantial price increases, or similarly. Theory of harm is a variable reflecting how the EC argues the case. Table 1a explains how I construct the theory of harm variable. Overall, CoordEff equals 1 if in the decision text, the most plausible theory of harm is based on coordinated effects, which typical happens when predicted combined market share is below 40 percent 16. If a merger is argued to be assessed under noncoordinated-effect theory, in other words, unilateral-effects theory, it is set to Coordinated-effects merger: the merger may change the nature of competition [making firms] significantly more likely to coordinate and raise prices or otherwise harm effective competition. A merger may also make coordination easier, more stable or more effective for firms, which were coordinating prior to the merger (EC Horizontal Merger Guidelines - 22) 14

15 The group of market variables relates to the scope of the geographic market in which the merger was seen to be most problematic. The problematic markets could be either national or EU/US wide or worldwide. For a merger involving more than one problematic product or market, the most severe product and market are coded. The political variables are defined according to the firms nationalities. They are considered as proxies for political factors. For example, if the merger involves US firms, the likelihood of challenge would be decreased because politics might cause pressure on the EC s decision whether or not to challenge a merger. 4.4 Descriptive Statistic Table 2 presents some basic descriptions of the statistic in term of mean, max and min values in the pooled sample and the pre- and post-samples. 43 percent of the mergers were notified to the EC before the reform and 51 percent of the cases required deeper investigation (Phase 2). The pooled data suggests that a great majority (83 percent) of the mergers involved unilateral-effects, which is somewhat related to the high mean value of the post market share (above 65 percent). The share of coordinated-effects mergers is significantly higher in the post-reform sample than pre-reform (21 vs 15 percent). 60 percent of the mergers created high barriers to entry and 77 percent of the mergers were challenged by the EC. The shares of challenged mergers are similar in the pre- and post-reform subsamples. The pooled sample also includes 39 percent of merger notifications with vertical ramifications. Overall, the mean values of the explanatory variables in pre-and post-subsamples are quite similar, which initially suggests that the reform had only a weak impact on the decision process. 5. Model Specification In the analysis, the main focus is the interaction effect between the reform and the theory of harm variable (Re.CoordEff). This means that I want to analyze the heterogeneous effects of the reform Non-coordinated-effects merger: By eliminating the competitive constraint between the parties, a horizontal merger may allow the merged firm to increase its prices regardless of the response of its remaining competitors. A merger which has these characteristics is commonly said to give rise to unilateral effects, though the Notice has chosen to coin a new term, non-coordinated effects to capture this class of case. See Derek Ridyard- The Commission s New Horizontal Merger Guidelines- An Economic Commentary- GCLC Working Paper 02/05 15

16 with mergers assessed under the different theory of harm, either coordinated-effects theory or unilateral-effects theory. I apply a probit models taking the following form: P(Challenge = 1 mergers) = ф(δ 0 + δ 1 Reform + δ 2 CoordEff + δ 3 Re. CoordEff + k β k X k + ε) where Challenge takes value 1 if the EC challenged a merger. X is a set of explanatory variables, as explained in Section 4, excluding Reform and CoordEffI. Adding interaction term, Re.CoordEff, to the regression model can greatly improve understanding of the probability of challenge to a coordinated-effects merger and a unilateral-effects merger before and after the reform. A significant estimate of the interaction term δ 3 means that the coordinated-effects mergers and unilateral-effects mergers responded differently to the reform. According to Buis (2010), to interpret an interaction effect in non-linear model, I first interpret it in term of marginal effects 17. I compute the marginal effects as the difference between the predicted probabilities of challenge to a coordinated-effects merger before and after the reform. A similar method is used to calculate the marginal effects of the reform on a unilateral-effects merger. 6. Basic Results 6.1 Whole sample Table 3 reports the effect of the reform on probability of challenge to a merger, with the interaction between the reform and the theory of harm on the whole sample. The coefficients from the probit models cannot be directly interpreted, hence I report marginal effects in the Appendix. Model EU1, with all key variables, is presented in column 1. It can be seen that all variables have significant impacts on the probability of challenge. The probability of a unilateral-effects merger being challenged is 82 percent before the reform while the odds after the reform is 76 percent, given that the rest of the variables are at their mean values 18. The reform reduces the probability of a challenge to a unilateral-effects merger by 6.3 percentage points. Perhaps this is a result of dominance no longer being enough for the EC to take an intervened decision. Conversely, the 17 Marginal effect after probit regression shows the change in probability when the predictor increases by one unit. All predictors are at their mean values. I apply margin command in Stata to show the likelihood of challenge for every combination of Reform and CoordEff. 18 The variables Reform and the CoordEff are allowed to vary between 0 and 1. Other explanatory variables are set at their mean values. 16

17 likelihood of a challenge to a coordinated-effects merger is much greater in the post-reform than in the pre-reform (86 percent vs 48 percent). The marginal effect of the reform for a coordinatedeffects merger is thus 38 percentage points. Prior to 2004, a coordinated-effects merger would not have raised most concerns if it did not create or enhance a dominant position or it took place in markets or in industries where ruled out the risk of coordination. The widening the EC s discretion for intervention of coordinated-effects mergers was also found by Ridyard (2005). Model 1 also shows that the average probability of challenge a unilateral-effects merger is higher than a coordinated-effects merger, by 34 percentage points before the reform. However, after the reform, a unilateral-effects merger is 10 percentage points less likely to be challenged than a coordinated-effects merger. This is possibly because non-dominance unilateral-effects mergers are also investigated under the unilateral-effects theory of harm after the reform, which may reduce the average probability of challenge. In line with many previous papers (Bergman et al., 2005; Bergman et al., 2010; Szücs, 2012), other variables play important roles in driving the decisions. The parameter corresponding to Entryindex indicates that a unit increase in entry barriers induces a 17 percentage points higher likelihood of challenge. Moreover, the probability of challenge increases strongly with a 1 percent increase in PostMS, by 0.33 percentage points. Interestingly, a Phase 2 merger is 26 percentage points less likely to be challenged than a Phase 1 case and the difference is statistically significant. In column 2, I control for the market variables and in column 3, the political variables are included in the whole sample. The magnitudes and signs for any of the key variables are not largely different in the models EU2 and EU3. The probability of challenge is not correlated to any market and political variables. This finding contrasts with the results presented by Szücs (2012) who found that mergers involving US firms have a lower probability of being challenged by the EC. Taken at face value, this suggests that any concerns about pressure from political reasons to challenge a merger have been removed. It is interesting to consider the reason as to why a merger closed in Phase 2 has around 26 percentage points lower probability of being challenged than one in Phase 1. The actual ratio of challenged Phase 1 mergers in the sample is about 82 percent. This ratio falls to 67 percent in Phase 2. There are two likely main reasons. 17

18 First, the result might be biased due to the data selection. There are only two types of decisions in Phase 1, compatible mergers (6(1)) and cleared mergers with remedies (6(1)(b)+6(2)). The Phase 1 mergers with remedies raise more concern about competition while the compatible mergers do not contain full information for the analysis and are obviously not challenged. The bias in 6(1)(b)+6(2)) mergers collection might lead to the high actual rate of challenge in Phase 1. Phase 2 varies with more types of decisions, such as unconditionally cleared mergers, mergers with remedies, prohibited mergers, and withdrawn mergers. Second, the result may be explained by bargaining power. In Phase 1, the EC has greater bargaining power than the merging firms. At the end of Phase 1, if the merging firms disagree with the EC s final decision, the EC can open a Phase 2 investigation. However, at the end of Phase 2, the decision can be appealed to the Courts, which moves control from the EC to the Courts. The Court will take into account all substantive evidences, which is costly and time-consuming for both the merging firms and the EC. In summary, the main impacts on the probability of challenge are entirely driven by the market shares (PostMS, Share2), the entry barriers (Entryindex), and other factors (Vertical, Evidences, CoordEff). The marginal effect of the reform on coordinated-effects mergers is larger than unilateral-effects mergers. After the reform, the EC seems slightly less likely to challenge unilateral-effects mergers but appears more stringent for coordinated-effects mergers. 6.2 Pre- and Post-reform samples Table 4 introduces estimations from the pre- and post-reform sub samples. Columns 1 and 5 introduces all key variables in the regressions. Columns 2 and 6 add the theory of harm variable. Models Pre3 and Post3 control for the market variables while models Pre4 and Post4 also include the political variables. The Entryindex and PostMS remain main indicators for prediction of challenges in all regressions. The marginal effects of the barriers to entry is 17 percentage points on average in the Model Pre4 while it slightly reduces to 15 percentage point in the Model Post4. Before the reform, by controlling for the market variables and including political variables, the marginal effect of PostMS is 0.55 percentage points. After the reform, a merger is only 0.29 percentage point more likely to be challenged if it has a 1 percentage point higher combined market share. 18

19 Many variables, for example Vertical and Evidences, are statistically significant in the Pre models while they do not have any significant impact on the probability of challenge in the Post models. (Model Post4). Prior to 2004, if there are vertical ramifications of a horizontal merger, this creates a 14 percentage points greater likelihood of the merger being challenged. Political factors do not seem to drive decision before the reform. However, the Model Post4 shows that if both merging firms are from the US, the merger is less likely to be challenged in the postreform period, by around 25 percentage points. Even if the theory of harm variable does not show any significant estimates in the subsamples, the signs of CoordEffI still partially suggest that coordinated-effects mergers are less challenged before the reform and more challenged after the reform than unilateral-effects mergers. In general, entry barriers remain a key factor while the combined market shares play a smaller role after the reform. Other variables, such as Evidence, and Vertical, are significant before the reform but have no significant impacts on the odds of a challenge after the reform. 6.3 Model Fit To measure the goodness of fit, I calculate the percentage of correctly predicted cases for each model. Under this approach, I consider a predicted probability of challenge larger than or equal to 50 percent as a prediction of a challenged case and a predicted probability of challenge lower than 50 percent as a prediction of predict an unchallenged case. A case is counted as correctly predicted if the prediction is similar to the actual decision. Finally I can calculate the percentage of observations predicted correctly. According to this explanation, all models seem to report very good results with more than 80 percent correct predictions. The Post models generally perform better than the Pre models. Especially, the Model Post4 including the market and the political variables fits up to 91 percent. In the whole sample, the models EU1, EU2, and EU3 show a similar success rate (around 83 percent). 6.4 Hausman Test Following Szücs (2012), a generalized Hausman specification test is employed to compare the coefficients of the Pre and the Post models. The test is based on the joint variance/covariance 19

20 matrix of the models. The Hausman test checks a more efficient model against a less efficient but consistent model to make sure that the more efficient model also gives consistent results. The Hausman statistic is distributed as Chi-square and is computed as H = (β c β e ) (V c V e ) 1 (β c β e ) Where βc is the coefficient vector from the consistent estimator; βe is the coefficient vector from the efficient estimator; Vc is the covariance matrix of the consistent estimator; and Ve is the covariance matrix of the efficient estimator. The null hypothesis is that there are no systematic differences between the two estimators. By comparing the Model Pre3 and Post3 in Table 4, there are significant differences in the coefficients. The null hypothesis is rejected with p= Same result is obtained by comparing the Model Pre4 and Post4. Therefore, it is more reliable to use separate models to predict the EC s decisions before and after the reform. 7. Comparison of Merger Enforcement Policies In this section, I focus on comparing the pre-and post-models to evaluate the differences of enforcement policies before and after the 2004 reform. 7.1 Hypothetical Prediction The method of hypothetical prediction was applied in some previous studies (Bergman et al., 2010; Szücs, 2012). The idea is to consider how decisions of mergers would have been made, had they been assessed under the same regulation. The method consists of three steps. First, I use the estimated Pre models to predict the probability of challenge for the post-reform mergers. Second, the average of all predicted values is calculated, which shows the hypothetical probability of a challenge to a post-reform merger, had it been evaluated under the pre-reform rules. Lastly, I compare the hypothetical rate with the actual rate of challenge after the reform. 19 A command hausman in Stata, which is a general implementation of Hausman (1978) can be used to handle this task. The data is clustered by the reform period, and the command hausman is not efficient. An alternative solution in this case is using the command suest to compare the coefficients across different samples. 20

21 The process of predicting hypothetical rates of challenge of a pre-reform merger by feeding the pre-reform mergers into the Post models is similar. Table 5 presents the results from the comparison of the hypothetical and actual rates in the pooled sample. The first row shows the actual challenge rates in the pre-and post-reform subsamples. Before the reform, 77 percent of merger notifications are challenged while after the reform, the ratio is slightly higher with 78 percent. The predicted challenge rate using the Pre models on the post-reform sample is greater than the actual rate (around 82 percent vs 78 percent) and there are no big differences in the predictions between the Pre models. The hypothetical rates from the Post models are substantially below the actual rate. The gap between hypothetic rate from Post3 and the actual rate is up to 7 percentage points while by including political variables in Post4, the error rate rises to 10 percentage points. To support the above results, Figure 6 plots the predicted probabilities, based on the Model Pre4 and Post4 for each observation in the pre- and the post-reform sample. Each symbol in the graph represents a merger (a triangle corresponds to a cleared case while a circle symbol is an intervened case). The models Pre4 and Post4 s predictions are measured on the vertical and horizontal axis, respectively. A 45 degree line indicates positions where the Model Pre4 and the Post4 have same predicted challenge rate of a merger. When a symbol locates above the 45 degree line, this means that the old policy would have been more likely to challenge that merger than the new policy. Conversely, when a symbol locates below the 45 degree line, this indicates that the new policy is more aggressive than the previous one. The two policies are more different in their predictions when symbols are further from the 45 degree line. Panel A shows the predicted challenge rates of each merger before the reform. By feeding each merger in the pre-reform sample through the Model Post4, I obtain the set of hypothetical outcomes. The symbols locate considerably furtherly from the 45 degree line, which suggests that policy before and after the reform may vary considerably on specific cases. Many symbols cluster close to 100 percent probability of challenge. However, the Pre4 Model mostly predicts high probabilities, varying from 50 to 100 percent, while the Post4 Model has a wider range of probabilities. The old policy seems more aggressive to challenge a pre-reform merger than the new enforcement policy. 21