This just in:  Microsoft withdrew its most recent bid for Yahoo and announced it will not be making a hostile move for Yahoo.  This comes on the heels of the announcement a mere day ago that Yahoo and Microsoft were sitting down to try to hammer out a friendly deal.  Fickle, that Microsoft is!

Allow me to answer questions folks might ask in the aftermath:

1.  Question:  What does this retreat by Microsoft say about the economy and the M&A market? 

Answer:  Nothing.  Nada.  Microsoft wanted to buy Yahoo for cheap.  Yahoo wanted no part of that.  Over the past 20 months, while Yahoo’s stock has been weak, it has traded on-and-off in the $30-ish range.  Microsoft’s final $33 per share bid was nothing to write home about.  If Microsoft was making a credible bid and they thought Yahoo was a good long-term strategic acquisition, we would have seen bid prices moving up further than they have over the past three months.

2.  Question:  What is going to happen on Monday to Yahoo’s stock price? 

Answer:  Yahoo’s stock price is going to get pummeled by arbs exiting their short-term investment.  The drop in Yahoo’s stock price will mean nothing of substance.  I promise.  So, while the media is going to get all excited on Monday about the drop in price, and the 5 p.m. news on Monday is going to talk about Yahoo being the day’s biggest loser, ignore the chatter.  Or buy Yahoo stock while it is cheap.

3.  Question:  Is the Yahoo board going to get sued?  Wasn’t this a good deal for Yahoo and the Yahoo board just gave it away?

Answer:  No and no.  Well, “yes” and no.  Yahoo’s board has already gotten sued both by shareholders who thought the Yahoo board should have taken the Microsoft offer and, oddly, from shareholders who thought Yahoo was favoring Microsoft.  Either way, I think those suits are non-starters.  Again, Microsoft was not offering a huge premium for Yahoo.  If I were on the Yahoo board, I would have said “no,” too. 

4.  Question:  Is Microsoft just bluffing?  Will they come back with a better bid?

Answer:  I hope not.  I am not convinced that Microsoft yet has a really solid reason for why they need to buy Yahoo, other than thinking they could get Yahoo for cheap.  Now that Microsoft realizes it cannot buy Yahoo for cheap, I doubt they will be circling back around in the short term.  The fact that Microsoft announced tonight that it did not intend to make a hostile bid speaks further to the dim chances they will circle back around in the short term.

To that end, Microsoft should thank the Yahoo board that the Yahoo board stopped Microsoft from making a purchase that does not make a whole lot of sense.  Am I the only person who remembers the AOL-Time-Warner deal from just under a decade ago that is NOW being unwound?  That deal NEVER made sense, and, LOOK, ten years later, it is being unwound. 

Note to Microsoft CEO Steve Ballmer:  Send Yahoo CEO Jerry Yang a nice fruit basket on Monday, to thank him from saving Microsoft from its urge to merge.

Amit Gandhi, Luke Froeb, Steven Tschantz and Gregory Werden have published “Post-Merger Product Repositioning” in the Journal of Industrial Economics.  (HT: Luke).  The critical insight is that the conventional unilateral effect incentive to raise prices post-merger is offset by the incentive to “separate” in product space.  Here is the abstract:

This paper analyzes the effects of mergers between firms competing by simultaneously choosing price and location.  Products combined by a merger are repositioned in away from each other to reduce cannibalization, and non-merging substitutes are, in response, repositioned between the merged products.  This repositioning greatly reduces the merged firm’s incentive to raise prices and thus substantially mitigates the anticompetitive effects of the merger.  Computation of, and selection among, equilibria is done with a novel technique known as stochastic response dynamic, which does not require computation of first-order conditions.

One last issue with respect to ex ante competition and merger analysis.  What if it could be demonstrated convincingly that XM and Sirius payments to automobile manufacturers. The DOJ hints at this possibility in the press release:

XM and Sirius engaged in head-to-head competition for the right to distribute their products and services through each car company. As a result of this competitive process, XM and Sirius have provided car manufacturers with subsidies and other payments that indirectly reduce the equipment prices paid by car buyers to obtain a satellite radio.

The general approach of the Merger Guidelines is that efficiencies and consumer welfare benefits in product markets outside the relevant market don’t count for the purposes of Section 7 analysis.  I understand that some arbitrary rules about the scope of the competitive effects analysis must be made in order to make the problem tractable, but I tend to think the exclusion of these benefits from the calculation doesn’t make any sense.

The DOJ leaves open the possibility here that these subsidies would be passed on to consumers in the form of “indirectly” lower prices for the satellite radio equipment and so one might think of these as “in the relevant market.”  But in my analysis of slotting contracts with Ben Klein involving payments to multi-product retailers like supermarkets, we show that one reason why supermarkets prefer to receive lump sum payments rather than wholesale price reductions is that the supermarket is not forced to pass on the payments in the form of lower prices on the particular product.  In other words, a slotting fee on Coca-Cola is not likely to be passed on in the form of lower prices on Coca-Cola. There is little doubt that the payment is ultimately passed on to consumers in the competitive retail environment, however.  Supermarkets pass on these payments in the form of various price and non-price benefits on margins that will have the greatest impact of store traffic and inter-retailer competition.  For example, supermarkets may use payments to subsidize lower prices on staples that drive inter-store substitution or non-price amenities like a deli, longer hours, etc.

The point is that the economics of pass-through of these ex ante payments in the multi-product retailer context is much more complex.  However, the Merger Guidelines limit the complexity by arbitrarily limiting consideration of efficiencies to those within the relevant product market (in my example above, soda) and not including the other benefits accumulated by consumers as a result of the payments.  This is odd from a consumer welfare perspective.  One can understand the 2 year timing limitation as an arbitrary but necessary mechanism for limiting the complexity of antitrust analysis or the operation of some discount rate on future consumers.  I think a reasonable argument can be had about the merits of this approach given our limited ability to make predictions into the future (see generally Katz & Shelanski on the topic of Mergers and Uncertainty).

But I view the limitation on “out of market” consumer welfare benefits as less defensible in the context of multi-product retailers as in this slotting fee situation.  If the payments on Coca-Cola are passed on along some other price or non-price dimension, it is generally the same consumers accumulating the benefits and there is very little doubt that these payments are passed through in competitive retail environments.  To know that economic theory and empirical evidence suggests that these payments are improving consumer welfare — the very same class of consumers in the supermarket — but prevent consideration of those benefits as an efficiency strikes me as both arbitrary and perverse.

Tulane’s annual “Corporate Law Institute” is coming up!  The conference - widely viewed as the must-attend deal conference of the year is April 3 and 4 (only two weeks away).

The roster for this year’s conference reads like a who’s who of the deal world, with a range of Delaware jurists, investment bankers, top lawyers, and Wall Street media on the two days worth of panels.

The conference, which is organized by practitioners (not Tulane folks), was started twenty years ago by former Delaware jurist and Tulane Law alum former Justice Andrew Moore.  (As you corporate law wonks know, Justice Moore wrote several of the big takeover opinions from Delaware in the mid-1980s.  Many in the corporate law world were scandalized when Justice Moore was not reappointed when his term expired, but, based on the takeover opinions he penned, those of us who are cynical about just how political and pro-defendant Delaware tries to be were not surprised.)  Justice Moore will be making an appearance on the 20^th year retrospective panel at the Tulane conference.

The conference should be stupendous, and I hope those of you who are reading this and will be attending the conference will make it your business to introduce yourselves to me.  I will be on the private equity panel on Friday, but I will be attending both days of the conference in full.

The specifics of the conference are here.

From the WSJ Online:

The transaction had faced stiff opposition in Brussels from Google rivals including Microsoft Corp. and Yahoo Inc., as well as privacy advocates who fretted that a combined company would control a vast storehouse of data on Web users and their surfing habits. But European Commission antitrust officials early on ruled out examining the privacy implications of the deal, resulting in a conventional merger analysis that left fewer ways for the deal to be blocked. In the end, the EU concluded that the still-nascent online-advertising market is changing quickly enough and has enough competitors that a combined Google-DoubleClick wouldn’t be able to shut out rivals. The purchase “would be unlikely to have harmful effects on consumers,” the EU said in a statement. The EU’s approval had been expected. The U.S. Federal Trade Commission gave its blessing, in a 4-1 vote, in December.

UPDATE: Here is more from Google’s Eric Schmidt and a few excerpts from the EC’s Press Release:

The Commission’s in-depth market investigation found that Google and DoubleClick were not exerting major competitive constraints on each other’s activities and could, therefore, not be considered as competitors at the moment. Even if DoubleClick could become an effective competitor in online intermediation services, it is likely that other competitors would continue to exert sufficient competitive pressure after the merger. The Commission therefore concluded that the elimination of DoubleClick as a potential competitor would not have an adverse impact on competition in the online intermediation advertising services market.

And with respect to non-horizontal issues the Commission:

found that the merged entity would not have the ability to engage in strategies aimed at marginalising Google’s competitors, mainly because of the presence of credible ad serving alternatives to which customers (publishers/advertisers/ad networks) can switch, in particular vertically integrated companies such as Microsoft, Yahoo! and AOL. The market investigation also found that the merged entity would not have the incentive to close off access for competitors in the ad serving market, mainly because such strategies would be unlikely to be profitable.

WSJ Deal Journal reports some important movement on the antitrust and private equity front.  Specifically, Judge Richard Jones (W.D. Washington) granted the defendants’ motion to dismiss in Pennsylvania Avenue Funds v. Borey, dismissing the plaintiffs’ allegations that two private equity firms had violated the Sherman Act by bidding jointly on the target company (Watchguard Technologies) in order to “artificially fix the price … or rig the tender offer bids for WatchGuard shares” after initially submitting independent bids.

Wilson Sonsini, who argued the successful motion, has posted an informative Client Alert summarizing the highlights of the decision.  Apparently, the Court rejected the per se characterization of joint bidding because it recognized the potential for joint bidding to increase rather than suppress competition in some circumstances.  The court found that the bidding arrangement could not survive a motion to dismiss on the alternative rule of reason characterization because ”dozens of other suitors who expressed interest in WatchGuard refused to make bids. . . . The result was a contest for corporate control in which it appeared that there were only two bidders, but the appearance is a mirage. An acquiror who believed that WatchGuard was worth more than [the] bid could have made a topping bid. The agreement between [the funds] would have had no effect on such a bid. Moreover, had WatchGuard’s shareholders believed that the [] bid was too low, they retained power to reject the merger by voting it down.”  Finally, it is worth noting that Judge Jones did find that the bidding arrangement was not impliedly immune from the antitrust laws because of overlapping securities regulations.

Private equity deals have been the subject of a good deal of speculation in antitrust circles in the past several years as bidding arrangements are the subject of pending litigation and have come under the scrutiny of the Department of Justice.  Its just one decision, but this one seems pretty dismal for plaintiffs in these private equity collusion suits.  Judge Jones’ decision seems to suggest that in the post-Twombly world, and with the market definition problems inherent in a rule of reason type case in the “market for corporate control,” plaintiffs are going to have a difficult time surviving the pleading stage without a plausible story that a specific “club deal” is tainted by collusion with a tangible impact on acquisition price.   I just don’t know if that kind of evidence is out there.  Its certainly tough to get without the benefit of discovery.  Anyway, I thought that the “club deal” collusion story was about facilitating tacit or explicit collusion on a series of deals (you don’t bid here, I won’t bid there).  That might be much harder to identify in practice.

But this is not the last of these suits.  It will be interesting to see how the plaintiffs antitrust bar adjusts to this ruling in future cases.

Microsoft has made a bid for Yahoo, and the Yahoo board of directors is anticipated to use the Nancy Reagan “Just Say No” defense.  I feel like I’m back in the 1980s merger boom. 

Several thoughts:

1.  Rumor has it we are in a recession.  It is likely then that Yahoo stock is currently trading at a price that is not its highest.  Indeed, Microsoft’s bid for Yahoo is basically a big fat memo to Wall Street, in bolded all caps, indicating it (Microsoft) thinks Yahoo is a good buy.  How long before other bidders get the clue and come knocking on Yahoo’s door?

2.  Debt is cheap these days.  Super cheap.  Cheaper than it was in the 1980s when we saw a wave of debt-financed takeovers.  If Yahoo really is a bargain at its current price, other bidders will appear, using a good chunk of debt-financing, if necessary, to make their bids.

3.  If other bidders show up, can the Yahoo board members continue to “just say no” without violating their fiduciary duties?  At least for now, I am of the view that the Yahoo board can easily continue to keep the door to bidders closed.  Yahoo stock traded around $27-ish over the past year, and Microsoft is now offering $31 per share.  Given that, back in Jan. of ’06, when the S&P 500 and the DJIA were both weaker, Yahoo was trading in the vicinity of $40 per share, I have no problem thinking the Yahoo board can embrace their inner Nancy Reagan until a bidder steps forward with an offer well over $40 per share.

4.  Yahoo’s dance with Google is an interesting defensive move, making me think of the white knights, crown jewels, and lock-ups of the days of yore.

5.  Am I the only one who finds it *very* ironic that Microsoft is making a bid for Yahoo only days after AOL Time Warner has made clear it is going to try to undo its mega-merger from seven years ago between AOL and Time Warner?  Note to Microsoft:  It is important to have very specific business justifications – and related business plans – before indulging your urge to merge.

The M&A world seems to be flashing back to the 1980s.  Debt is cheap, private investors are bold, and some mega-mergers from the late 1990s might be perfectly situated for bust-ups.  It is just a matter of time before everyone is wearing parachute pants again.  You heard it here first. 

The Economist (HT: 26econ.com) sketches out an interesting theory on the proposed Microsoft-Yahoo merger:

The only grounds on which a trustbuster could plausibly oppose Microsoft buying Yahoo!—that it is possible to exercise monopoly power in online search and advertising—surely apply even more strongly to Google. Indeed, some antitrust experts are surprised that Google has not already come under serious assault from the trustbusters, especially because, as Mr Ballmer points out, the “one player” has been “consolidating its dominance through acquisition.”

Indeed, even if Microsoft believed that it would be prevented from buying Yahoo! on antitrust grounds, it might make sense to push for the deal, if only to force the antitrust authorities to take a serious look at issues of market power in the online search and advertising market, which would inevitably lead them to Google.

The FTC recently released its agenda for its upcoming public workshop on February 12 on “Unilateral Effects Analysis in Litigation.”  The announcement motivates the conference as follows:

Among economists, unilateral effects is a widely accepted theory of competitive harm. Yet, the federal antitrust agencies have experienced limited success litigating differentiated product cases in district courts under unilateral effects theory. Calling together leading lawyers and economists to discuss these issues is a central component of Chairman Majoras’ efforts to refine the Commission’s ability to explain and prove cases based on unilateral effects theory.

The agenda is available here. 

At Overcoming Bias, Robin Hanson points to the absence of decision markets evaluating competitive conditions in the post-merger world as evidence that “these companies are just not serious about finding the highest value applications of prediction markets.” Here’s a description of the markets that Robin has in mind:

Decision markets could say whether this merger is good for shareholders, by estimating the combined stock price given a merger, and given no merger. Similarly, decision markets could say whether this merger is good for these firms’ customers, by estimating the price and/or quantity of web ads given a merger, and given no merger. This might help convince regulators to approve the merger.

I certainly agree that these types of internal decision markets might be relevant to both firms contemplating mergers and to antitrust regulators. I’m also very hawkish on the use of prediction markets within firms and to inform policy as a general matter. But I’m not sure that Robin is right that the problem in the merger context is that firms do not take prediction markets seriously enough. At least, thats not the only problem. One immediate and important problem is that these markets might also help convince regulators to reject the merger based on estimates of post-merger prices. The type of information is likely to be a more accurate form of information that government agencies already seek from the merging parties, usually in the form of internal documents, analyses, and forecasts, to analyze the likely competitive effects of a proposed merger.

The antitrust concern is obvious: any information created via internal prediction markets, including information that suggests that prices will increase, will surely be used by the agencies to argue that the merger will violate the Clayton Act. I do wonder whether these types of concerns provide a substantial additional expected costs to the establishment of decision markets on antitrust events, e.g. exactly the types of events where prediction markets might be extremely useful to firms. My hunch is that if antitrust counsel were sitting in the room when firms are contemplating launching a prediction market on a merger or other antitrust event, he or she might strongly oppose the idea for fear of explaining the “hot documents” that it might produce.

The above discussion assumes that we are talking about “internal” prediction markets. And I do believe that the types of antitrust concerns raised there are real and possibly constrain adoption of these markets for antitrust events in the real world. However, if we allow for prediction markets where folks outside the firm (e.g. competitors) can also participate, the law professor can’t help but raise a scenario fit for an antitrust exam hypothetical:

Firm A launches a prediction market on antitrust event X (lets say X = raise prices 5% next month). In response, or perhaps simultaneously, rival Firm B also launches a market in which antitrust event Y (Y = raise prices 5% next month) is actionable and Firm A managers and employees can participate. One can also think of more precise and problematic contracts in terms of the prospects for collusion, e.g. “Firm A’s price on January 1, 2008 is greater than or equal to $5.50.” But lets leave that contract aside for the moeBoth firms increase prices by 5% at the start of next month. The DOJ sues alleging that A and B have reached an agreement to raise prices in violation of Section 1 of the Sherman Act. What result? What about if the FTC sues under Section 5 of the FTC Act as a stand-alone offense? Of course, this example is not really about prediction markets. Its about collusion.

Some economists who favor the use of prediction markets have argued for safe harbors for their use from gambling regulations. That’s the easy case since the social value of gambling laws is not likely to be low or perhaps negative whereas there is little dispute about the potential social value in prediction markets. I wonder if these economists would favor a similar safe harbor from antitrust regulations? I can already hear Geoff pointing out that antitrust regulations do not have much social value either. So what about a safe harbor from hard core cartel offenses under Section 1? Or a “safe harbor” preventing antitrust regulators from using internal prediction markets as evidence in court to prove the likely competitive effects of a merger?

I am very pleased to announce the “Merger Analysis in High Technology Markets” on behalf of my colleague Tom Hazlett, myself, and the Information Economy Project of the National Center for Technology and Law. The conference will be held at George Mason University School of Law on February 1, 2008 from 8:15 am-2:30 pm. Below is the conference agenda and information about attending. We hope to see you there!

INFORMATION ECONOMY PROJECT
THOMAS W. HAZLETT, DIRECTOR
DREW CLARK, ASSOCIATE DIRECTOR
JOSHUA D. WRIGHT, CONFERENCE ORGANIZER

MERGER ANALYSIS IN HIGH TECHNOLOGY MARKETS

HAZEL HALL * GMU SCHOOL OF LAW * ROOM 121

8:15 WELCOME * THOMAS HAZLETT (GMU)

8:20 MORNING KEYNOTE

8:45 PANEL 1 * MODERATOR: KEN HEYER (DOJ)

HOWARD SHELANSKI (UC BERKELEY)
TECHNOLOGICAL INNOVATION AND MERGER POLICY’S THIRD ERA

MICHAEL BAYE (FTC)
MARKET DEFINITION IN ONLINE MARKETS

RICHARD GILBERT (UC BERKELEY)
SKY WARS: THE ATTEMPTED MERGER OF DISH/ DIRECTV

10:00 BREAK

10:15 PANEL 2 * MODERATOR: MICHAEL VITA (FTC)

HAL SINGER (CRITERION) & ROBERT HAHN (AEI)
AN ANTITRUST ANALYSIS OF GOOGLE’S PROPOSED ACQUISITION OF DOUBLECLICK

MARY COLEMAN (LECG)
NICE THEORY BUT WHERE’S THE EVIDENCE?: THE USE OF ECONOMIC EVIDENCE TO EVALUATE VERTICAL AND CONGLOMERATE MERGERS IN THE US AND EU

LUKE FROEB (VANDERBILT)
MERGERS AMONG FIRMS THAT LICENSE COMMON INTELLECTUAL PROPERTY

11:30 BREAK

11:45 PANEL 3*MODERATOR: JONATHAN BAKER (AMERICAN)

BRUCE ABRAMSON (CRAI)
ARE “ONLINE MARKETS” REAL AND RELEVANT?

THOMAS HAZLETT (GMU)
ANTITRUST IN ORBIT: SOME DYNAMICS OF HORIZONTAL MERGER ANALYSIS IN THE CASE OF XM-SIRIUS

J. GREG SIDAK (GEORGETOWN)
EVALUATING MARKET POWER WITH TWO-SIDED DEMAND AND PREEMPTIVE OFFERS TO DISSIPATE MONOPOLY RENT: LESSONS FOR HIGH-TECHNOLOGY INDUSTRIES FROM THE PROPOSED MERGER OF XM AND SIRIUS SATELLITE RADIO MERGER

1:00 LUNCH

LUNCH KEYNOTE

2:30 ADJOURN

VENUE: The George Mason University School of Law, Hazel Hall, 3301 Fairfax Drive, Arlington, VA 22201 (near the Virginia Square-GMU Metro — Orange Line). Admission is free, but seating is limited. To reserve your spot, please email Drew Clark: iep.gmu@gmail.com. Parking (at market rates) is available in the GMU Foundation Bldg., 3434 Washington Boulevard. An Arlington campus map is found here: http://www.gmu.edu/departments/infoservices/ArlingtonMap07.pdf.

A trio of Federal Trade Commission economists (Christopher Taylor, Paul Zimmerman, & Nicholas Kreisle) have revisited Justine Hastings’ 2004 AER analysis of the ARCO/ Thrifty vertical merger in their paper, “Vertical Relationships and Competition in the Retail Gasoline Market: Comment.”  (HT: Danny Sokol).  Hastings’ analysis is viewed as particularly important because it is one of the few empirical results that suggests that vertical integration is associated with lower retail prices and that regulations restricting vertical integration might improve welfare.

The FTC economists  challenge both the underlying empirical results using a similar differences in differences methodology and also take a closer look at the welfare implications of Hastings’ theoretical model.  Their conclusion:

According to Hastings’ analysis of the W-L data, the ARCO/Thrifty acquisition increased prices at nearby competing stations by $0.05 per gallon, on average. Our analysis of the OPIS data provides a very different estimated price effect of this transaction, suggesting that if there was any price effect, it was an order of magnitude smaller. In a number of instances we cannot reject the hypothesis of no effect at standard levels of significance. While we used a different data set, we have found no reason that would explain this discrepancy. Regardless of which data set more accurately depicts the transaction’s actual impact on prices, our theoretical analysis reveals some difficulties in inferring welfare effects from price changes when consumers attach value to particular brands of gasoline.

This sort of merger retrospective work is very important for formulating competition policy and regulation that is well grounded in both theory and evidence.  As the FTC authors notes, however, their is still a significant shortage of this type of work.  For those interested in the state of evidence on vertical integration, Francine Lafontaine and Margaret Slade also recently published a survey on the topic in the Journal of Economic Literature (available here).

Professor Bainbridge offers a correction to Keith’s Starbucks analysis by pointing out that Starbucks does not have franchisees. I don’t think the franchise/ franchisee distinction has much to do with Keith’s conclusion that whatever is going on is not an antitrust problem. But the Professor is on to a really cool question about franchising and vertical integration. Professor Bainbridge presents the contrasting franchising decisions by Starbucks and Subway as a transactions cost puzzle and links to a fuller analysis of this problem here:

What bugs me about the Subway v. Starbucks problem is that I can’t see any reason to believe that Subway’s transaction cost schedule is going to differ from that of Starbucks.

Bainbridge continues with the conventional account of the economics of franchising, focusing primarily on monitoring costs:

Franchising gives a residual claimant-like status to the local franchisee, while the franchise contract gives the franchisee incentives to ensure that the local employees comply with brand requirements. Franchising thus can be understood as an adaptive response to the problem of monitoring numerous employees in countless locations.

If this analysis is correct, one would expect to see corporate ownership in settings where monitoring via a vertically integrated management structure can be effected at low cost (relative to situations in which franchising dominates). But does Starbucks really face lower monitoring costs than Subway? If not, did Starbucks make an economic error by not going the franchise route?

The comments to Professor Bainbridge’s prior analysis from the folks at Marginal Revolution (and others) following the post hint at cross-store cannibalization as the key to the economic explanation. This is basically right, or at least, on the right track. But I think all this talk about “monitoring” and “transactions costs” is covering up some really interesting economics that shed some light on vertical contracting more generally. Don’t get me wrong, the critical variable that should influence the vertical integration decision here is indeed (as Professor Bainbridge says) the monitoring costs of franchisor owned outlets relative to franchised oulets. But I think these rather vague labels are blurring some important underlying economics.

So what’s going on with Starbucks’ decision to vertically integrate its outlets? I offer some analysis below the fold.

(more…)

Paul asks about the Vegas odds on XM/ Sirius merger approval.  Its not quite Vegas, but Intrade is offering contracts on merger approval on or before December 2007, March 2008, and June 2008.  They’re trading at 5, 50, and 70 respectively.   So Paul, any of those contracts look good to you?