Do Mergers Matter?


Mergers in Perspective, by Yale Brozen, Washington, D.C.: American Enterprise Institute, 1982, 85 pp., $14.95/$6.95.

Mergers in Perspective contains a wealth of information on the newly important merger issue. Yale Brozen, professor of business economics at the University of Chicago, begins by pointing out that the United States has the world's most restrictive laws with respect to mergers. The central issue of concern in the book is the wisdom of such laws.

Brozen first summarizes the US merger experience, with merger waves occurring in 1898–1902, 1926–30, and 1966–70. A fourth wave seems to be materializing at present. The character of these mergers has changed drastically. Horizontal mergers dominated in the 1898–1902 period, when the notorious trusts in oil, tobacco, steel, and other industries were formed. In the 1960s and today, conglomerate mergers for market extension, product extension, or between unrelated firms have dominated. This change in the nature of mergers has resulted primarily from changes in antitrust legislation and enforcement, with horizontal mergers between significant competitors almost totally prohibited since 1950.

Brozen subsequently examines whether these merger waves led to rising industrial concentration. While the 1898–1902 wave did, the evidence indicates that average concentration in American industry has changed little throughout the rest of the 20th century. Neither government policy nor the actual level of merger activity seems to have had any significant effect on concentration. Even the mergers of the 1898–1902 period had little permanent effect on the structure of American industry. Brozen argues, with considerable evidence and logic to support his position, "that fundamental technological and economic forces determine industry structure and that it is little different today from what it would have been without the turn-of-the-century consolidations."

Brozen devotes a major portion of the book to conglomerate mergers because of their current relevance, first analyzing the effect of conglomerates on efficiency. Dennis Mueller has argued that conglomerate mergers do not increase efficiency because the acquiring companies earn only normal returns on the assets acquired. Brozen criticizes this reasoning because it ignores the existence of a competitive market for acquisitions. The prices of companies eligible to be acquired are bid up until only a normal return can be earned by the acquiring company. More meaningful evidence supporting the greater efficiency of the acquiring company lies in the premiums paid for acquired companies. These premiums have averaged 25 percent or more since 1955.

Additional evidence on the efficiency of conglomerates is provided by their greater value added per employee and their higher level of wages relative to single-industry firms. Exactly why conglomerates are more efficient is unclear. Their greater efficiency may be a result of joint use of facilities and personnel, removal of incompetent managers, closure of unproductive operations, or advantages in raising capital.

Brozen next looks at the question of conglomerate power. He considers the predatory pricing issue, explaining the view of most economists specializing in industrial organization that an attempt to monopolize by temporarily selling at a loss to bankrupt competitors is highly unlikely to be a profitable policy. While conglomerates do have a superior ability to lose money, the amount that has to be lost in the act of monopolizing is so large that huge profits would have to be made on the monopoly established. But any attempt to raise prices inevitably must face the danger of entry of new competitors. Thus, the successful use of predatory pricing by conglomerates seems quite unlikely. Brozen effectively responds to such anticonglomerate arguments as the danger of reciprocal dealing and the possibility of mutual forbearance.

Some economists have argued that conglomerates should be forced to enter industries by beginning from scratch rather than merging with existing firms, claiming that the new entry would increase competition and that conglomerate mergers prevent this expansion of competition from occurring. Brozen points out that this argument ignores the most important reason for conglomerate mergers—the opportunity to acquire poorly managed assets. Evidence indicates that conglomerates generally acquire firms that are significantly less profitable than the average for their industries. After acquiring such relatively unprofitable firms, the acquirers, on average, are able to earn a competitive return. Thus, such conglomerate takeovers perform the socially valuable function of weeding out incompetent management. Barring such mergers would drastically restrict this social gain. Also, barring firms from selling their assets to large conglomerates would make development of new firms less attractive. Brozen concludes that restrictions on conglomerate mergers simply protect inefficient management and discourage the development of new firms.

Brozen next considers the issue of aggregate concentration (dominance of the entire economy by a small number of firms). He questions arguments regarding the dangers supposedly resulting from higher aggregate concentration. It is dominance of a market for a specific product that yields monopoly power. Huge size provides little power if substantial competition exists in every market. Brozen challenges the almost universally accepted position that aggregate concentration has been rising, arguing that a more reasonable interpretation of the evidence indicates the trend is toward declining aggregate concentration.

In examining the economic and political power of the largest firms in the US economy, Brozen claims that the giant firms of the past and present really have had very limited economic power. With respect to political power, it is the smaller (and more numerous) firms that generally have more influence. Government policy toward the oil industry has consistently favored independents over the majors. The huge firms in the automobile and pharmaceutical industries certainly have had little success in recent years in combatting government regulators. Farmers, trade associations of small firms, and organizations consisting of licensed professionals, on the other hand, seem to have much greater political influence.

Brozen concludes that, with respect to horizontal mergers, there is little need for government restriction. Even mergers for the purpose of monopolizing are generally unsuccessful in achieving that goal. Also, concentrated industries often perform better than unconcentrated industries, with only a very small number of competing firms necessary to force competitive pricing policies. With respect to conglomerate mergers, Brozen has no doubts at all—all restrictions should be eliminated. Basically, Brozen argues that mergers, rather than being a method of monopolizing, are actually a crucial element of the dynamic market process.

William P. Field, Jr., is a professor of economics at Nicholls State University in Louisiana.