a) Antitrust authorities at the Federal Trade Commission are reviewing your company’s recent merger with a rival firm. The FTC is concerned that the merger of two rival firms in the same market will increase market power. A hearing is scheduled for your company to present arguments that your firm has not increased its market power through this merger. Can you do this? How? What evidence might you bring to the hearing?
In order to prove to the Federal Trade Commission(FTC) that the recent merger between two companies will not increase the market power, we will be presenting the evidence as how this merger is in the interest of markets by using Herfindahl-Hirchman Index(HHI), which happens to be the vintage measure for determining the potential trust antitrust violations. The calculation of HHI is relatively simple and is performed by summation of the squared market shares for all the firms withi the industry:
HHI= ∑(market share of firm* 100)2
Important to note, not only this measure finds support in the academic fraternity, but is also supported by literature evidence. For instance, the first research paper that credited the use of the HHI Index in evaluating the mergers and their impact on market concentration was authored by Stephen Calkins in the year 1983. Later, US Department of Justice and Federal Trade Commission also authorized the use of HHI Index to evaluate mergers and how they affect the market concentration. Most recently, many research papers are also highlighting the use of the Herfindahl-Hirschman Index (HHI) by policymakers including banking regulators to evaluate merger proposals.
According to the original benchmark guidelines set forth by US Department of Justice and Federal Trade Commission in 1992 and then revised in the year 1997, if the post merger HHI is less than 1000, the industry continues to remain competitive. However, if the post merger HHI value is between 1000-1800, the industry turns moderately concentrated and in this case, FTC will compare pre-merger HHI and post-merger HHI value and if the change in such values is greater than 100 points, FTC can l challenge the merger on antitrust grounds. Additionally, if the post-merger value exceeds 1800, thus implies that the industry is highly concentrated. In this case also, the regulators will compare the pre-merger and post-merger HHI calculations and if the change is greater than 50, the merger will be most likely challenged by FTC.
Later on April, 2010, in order to provide the government agency with far more flexibility in its integrated approach to merger investigations , FTC reissued benchmark guidelines for HHI index. According to the new guidelines, if the post-merger HHI value of the industry is less than 1500, FTC will not challenge the merger. However, if the HHI value post-merger is greater than 1500, FTC will demand scrutiny or will directly challenge the merger, as the case may be on the basis of pre-merger and post-merger HHI value.
Henceforth, on the basis of new guidelines, we assert that since the HHI value post merger between our firm and the rival firm is less than 1500, the merger activity will not affect the industry concentration and should thus not be challenged according to new benchmark guidelines proposed by the US Department of Justice and Federal Trade Commission(FTC). Infact, with forecasted synergies out of the merger activities between the two firms, we will be able to pass on the benefit of economies of scale to the consumer and thus ensure a benefit for them and the market altogether.
b) Assume that the demand for plastic surgery is price inelastic. Are the following statements true or false?
-When the price of plastic surgery increases, the number of operations decreases.
False. As notified, the demand for plastic surgery is price inelastic. This implies that the percentage change in price is more than the percentage change in demand. In other words, the demand for plastic surgery operations is least affected by the price level and even if the price level increases, the surgeon may still continue to witness nil or negligible change in the demand level.
-The percentage change in the price of plastic surgery is less than the percentage change in quantity demanded.
False. As notified in the previous point, for a good or service with inelastic demand, the percentage change in the price level will be more than the percentage change in quantity demanded. For instance, as for plastic surgery operations, which face inelastic demand, the change in the price level will not affect the demand for the number of operations to a significant extent.
-Changes in the price of plastic surgery do not affect the number of operations.
True. Since the demand for plastic surgery operations is inelastic, this implies that any change in the price level will not have a significant impact on the demand for the number of operations. Important to note, the reason for inelastic demand for plastic surgery is because it is a medical treatment and over the top of that, a luxury treatment being afforded by upper middle class and rich segment of the society. Since these segments of the society are not concerned with price factor, the demand for such operations is least affected.
-Quantity demanded is quite responsive to changes in price.
False. Since the demand of plastic surgery operations is inelastic, demand will be less responsive to the price levels. In other words, the patient who are willing to undergo the plastic surgery, will not be affected by the price level and come what may, they will undergo the surgery. As explained in the previous points, plastic surgery is a luxury medical treatment and thus, the demand for such services is not affected significantly by the price levels.
-The marginal revenue of another operation is negative.
False. Marginal revenue refers to additional revenue earned by the firm from selling additional units of the good or service. Important to note, since the demand for plastic surgery operations is inelastic, the marginal revenue from each additional operation will rather be positive as with increase in price level, even if the demand is constant, the revenue figures will be higher for the surgeon.
c) SEC regulations require U.S. corporations to publish operating results on a quarterly basis. How does this short term time frame impact long term profit maximization? Should the SEC change their regulations of public corporations to require only annual reporting of operations? How might this impact stock price in the short term? How do you believe that management deals with these two sometimes competing goals?
The concern addressed here in the question is something not new, but rather a decades old issue,which the corporate world and its allies are discussing with SEC. Important to note, all the listed companies are required to file form 10-Q on the quarterly basis that details the quarterly performance of the company through updated financial statements and earnings. Unlike the annual report published in form 10-K, quarterly earnings are not required to be audited and can be issued on non-audited basis. According to SEC, quarterly earnings report is crucial as it results in improved communications with financial market, low share price volatility and higher valuations. In other words, while the eventual objective of every firm is wealth maximization over the long-term, however, quarterly earnings are considered as ladder of confirmation of short-term stability leading towards long-term viability.
However, top law firms, consultancy firms and market pundits have other things to say about the impact on quarterly earnings on the market functioning. In an article published in the Wall Street Journal, influential law firm, Wachtell, Lipton, Rosen & Katz was cited criticizing the mandate of releasing quarterly earnings reports by the publicly listed firm. The executives of the law firm said that the ritual of issuing quarterly reports is distracting the companies from long-term goals. In addition, the presidential candidate in the United States, Hillary Clinton and President of Blackrock Inc, Laurence Fink have also criticized the mandate of issuing quarterly reports as these magnates consider that quarterly reports are actually the gimmicks that provide short-term stock gains at the expense of long-term health. Even in one of her presidential debates, Mrs Clinton has pledged to introduce reforms that will help CEO’s and shareholders to focus on long-term goals rather than the next day.
While many activist shareholders and activists are still advocating in favor of quarterly performance, however, in another evidence against the ritual of quarterly earnings, Wachtell, Lipton, Rosen & Katz cited that rigid quarterly reporting requirements are just promoting short-term focus amongst the companies, investors and the market intermediaries, and even if regulators vow to have stringent regulations on quarterly releases also, it will just add unnecessary burden and cost for the companies, without providing useful or meaningful information for investors.
Therefore, considering the overall analysis, we can conclude that SEC should change their mandate for public companies of releasing quarterly earnings as apart from supporting shot-term liquidity, such actions are doing no good. Infact, high frequency of earnings announcement are just diverging the focus from the long-term objective of wealth maximization.
d) During the energy crisis of the 1970s, and again in the last 5 years, Congress bemoaned the “price gouging” and “windfall” profits of the major oil companies. In the 1970s Congress imposed an “excess profits tax” on these companies. It did not do so this time? What does this change show about how our understanding of the way the price system works to allocate resources has evolved? If “excess profits” are taxed away, where will oil companies get the money to fund new exploration and development of oil properties? Does it matter if these price increases are demand or supply induced?
The situation between the energy crisis during 1970’s and the present economic scenario has changed significantly. Back in the 1970’s, oil consumption in the United States was at peak because of the industrial revolution. However, while the demand was high, the internal supply was almost nil. The US based oil companies had to import oil from other oil producing countries to fulfil the demand. In fact, while the mid-east nations were discovering oil wells consistently, it was big US companies that offered them updated machinery and technology to extract the oil. Therefore, both from the production and sales point of view, the big oil companies in the United States were making huge profits and were eventually taxed at exorbitant rates by the US congress.
However, now the scenario is completely changed. During 2008, when the oil prices peaked at $150, US congress did smell yet another opportunity to reduce its fiscal deficit by taking taxing big oil companies like Exxon Mobil,Chevron and Royal Dutch Shell,who just like the 1970’s were making high profits. However, unlike 1970’s, US congress did not charge ‘excess profit tax’ from these companies because of the profit of big oil companies was not as high as it used to be in 1970’s and compared to other tech companies, there was no evidence of ‘excess profits’ here as while the average profit margins of oil companies was 8.3%, technology industry was earning 27.5% margin. Moreover, the US economy had turned more capitalists compared to 1970’s,which leaves the least authority with the government to determine different tax rates for different industries.
In addition, taxing the big oil companies with higher tax rates would have deterred them from making future investments and this would have been detrimental for the US economy, which at the time of 2007-08 was completely clutched with recession. Therefore, taxing these companies would have resulted in low business investment to explore new oil fields and as a result, minimal job creation in such scenario. Another concern for the government was that taxing oil companies at a higher rate would negatively affect oil companies and the situation could have gone worse in the form of supply squeeze.
On the demand and supply perspective, the increase in price of oil always had an important effect on the economy.
References
Benoit, D. (2015, August 19). Time to End Quarterly Reports, Law Firm Says. Retrieved August 29, 2016, from Wall Street Journal: http://www.wsj.com/articles/time-to-end-quarterly-reports-law-firm-says-1440025715
Hays, F. H. (n.d.). Understanding market concentration: internet-based applications from the banking industry . Journal of Instructional Pedagogies, 2-3.
Hseih, P. (2006). The misguided practice of earnings guidance. Retrieved August 29, 2016, from http://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/the-misguided-practice-of-earnings-guidance
Kaplan. (2011). Elasticity. In Schweser notes for CFA Exam (pp. 8-22). USA: Kaplan Inc.
Saxena, V. (2008, July 3). Does Big Oil's Apathy Justify Proposals to Tax Windfall Profits? Retrieved August 29, 2016, from http://seekingalpha.com/article/83717-does-big-oils-apathy-justify-proposals-to-tax-windfall-profits
