Unemployment: Italy

-Unemployment: those of working age who are without work, but available for work at current
wages.

-Claimant unemployment: percentage change of people claiming for unemployment related benefits
over the total number of full-time and part-time jobs available in the country.

-The [standardised] unemployment rate: measure of the prevalence of unemployment and it’s
calculated as a percentage by dividing the number of unemployed individuals by all individuals
currently in the labour force. During periods of recession, an economy usually experiences a
relatively high unemployment rate.

-Italy Unemployment Rate [http://www.tradingeconomics.com/italy/unemployment-rate]

-[Very recent Unemployment rates] The latest reported unemployment rate in Italy this year, has
been in October 2016 at 11.6%, a drop from the previous month. With that being said, the economy
rationalized 30 thousand jobs and 82 thousand people left the labour force. Hence with this
beneficial decrease in unemployment levels, came a slight fall in employment level by 0.1% as well,
inactivity rate rose by 0.2%. The fall in employment mostly comprises of women likewise with the
rise in inactivity rate, and less so with men. Moreover, youth unemployment fell by 0.4% to 36.4%.
This could be from increased recruitment and selection of younger workers, or the youth population
leaving the Italian labour force and travelling to other countries in Europe.

-Earliest unemployment rate in 1983 averaged at 9.36%, and the range of unemployment rate
reached 14% in November 2014 and record low of 5.7% in April 2007.

[http://ec.europa.eu/eurostat/statistics-explained/index.php/Unemployment_statistics]

[https://data.oecd.org/unemp/unemployment-rate.htm]

[https://data.oecd.org/italy.htm]

[https://www.dawsonera.com/readonline/9780273736936]

Reading list on BB
Mergers: motives for, impact of and EU policy towards
-Motives for , impact of and EU policy towards-
-Exam question 2016: a) Explain how the EU aims to protect consumer welfare through its regulation
of mergers : The issues surrounding efficiency savings and consumer surplus are important for the
theoretical background. The 2004 merger regulations need to be covered, and cases of relevance
should be raised.

b) Using recent examples, discuss the effectiveness of EU merger policy: Possible examples could
refer to horizontal, vertical and conglomerate cases. There is scope to refer to a range of recent cases
which have been examined by the EU, and original examples should be rewarded.

-Exam question 2015: Use recent relevant examples to show how EU merger policy aims to improve
the level of competition and consumer welfare in European markets.

-The issues surrounding efficiency savings and consumer surplus are important for the theoretical
background. The 2004 merger regulations need to be covered, and cases of relevance should be
raised. Possible examples could refer to horizontal, vertical and conglomerate cases. There is scope
to refer to a range of recent cases which have examined by the EU.

-Exam question 2014/2013: With reference to recent cases, evaluate the effectiveness of EU merger
policy in increasing competition and consumer choice.

-The issues surrounding efficiency savings and consumer surplus are important for the theoretical
background. The 2004 merger regulations need to be covered, and cases of relevance should be
raised. Possible examples could refer to horizontal, vertical and conglomerate cases.

-Merger: takes place with the mutual agreement of the management of both companies, usually
through an exchange of shares of the merging firms with shares of the new legal entity.

-Additional funds are not usually required for the act of merging and the new venture often reflects
the name of both the companies concerned.

-Takeover/ acquisition: occurs when management of Firm A makes a direct offer to the
shareholders of Firm B and acquires a controlling interest i.e. a direct transaction between the
management of the acquiring firm and the stockholders of the acquired firm.

- Usually requires additional funds to be raised by the acquiring firm (Firm A) for the acquisition of
the other firm (Firm B) and the identity of the acquired company is often subsumed within that of
the purchaser.

-In majority of cases, the distinction between merger and acquisition is difficult to make. Give the
e.g of SmithLKiline Beckman and Beecham.

-4 types of mergers:

1) Horizontal Integration

-Firms combine at the same stage of production, involving similar products or services.
-During the 60s over 80% of UK mergers were horizontal and despite a fall in the percentage, some
80% of mergers in the late 90s were still of this type. Can give a few egs. i.e. British Airways takeover
of British Caledonian in 1998.

- This integration may provide a number of economies at the level of both the plant (productive unit)
and the firm (business unit).

-Plant economies: may follow from the rationalization made possible by horizontal integration i.e.
production may be concentrated at a smaller number of enlarged plants, permitting the familiar
technical economies of greater specialization, separate process at higher output and application of
the ‘’engineers’’ rule whereby material costs increase as the square but capacity as the cube. All
these lead to a reduction in cost per unit as the size of plant output increases.

-Firm economies: result from growth in size of the whole enterprise, permitting economies via bulk
purchase, the spread of similar admin costs over greater output and the cheaper cost of finance and
so forth.

-Unilateral effects: merger reduces the number of firms, total supply falls and price rises.
Deadweight loss of welfare [lecture]

-Co-ordinating effects: increased likelihood of collusion following the merger. [lecture]

-Market Contestability: higher profits would encourage new firms if entry barriers and exit costs are
low. [lecture]

2) Vertical Integration

-Occurs when the firms combine at different stages of production of a common good or service. Only
about 5% of UK mergers are vertically integrated.

-Firms might benefit by being able to exert closer control over quality and delivery of supplies if the
vertical integration is ‘’backward’’, i.e. towards the source of supply. Factor inputs might also be
cheaper, obtained at cost instead of cost + profits. Can give eg. Of takeover of Texas Eastern by
Enterprise Oil.

-Vertical integration could be ‘’forward’’ towards the retail outlet. May give the firm merging
‘’forward’’ more control of wholesale or retail pricing policy and more direct customer contact. Can
give eg. Of Pearson plc of National Computer Systems.

-Vertical integration can often lead to increased control of the market, infringing monopoly
legislation. Give eg. Of M&S of suppliers.

-Entry barriers advantages and efficiency gains. [lecture]

3) Conglomerate Mergers

-Refers to the adding of different products to each firm’s operations.

-Diversification into products and areas with which the acquiring firm was not previously directly
involved accounted for only 13% of all mergers in the UK in the 60s. But by the late 80s the figure
had risen to 34%.

-The major benefit is spreading of risk for the firms and shareholders involved.

-Firms economies mentioned in 1), may also result from a conglomerate merger.

-The ability to buy companies relatively cheaply on the stock exchange, and to sell parts of them off
at a point later, because an important reason for conglomerate mergers in the 80s. e.g. takeovers by
Hanson plc of the Imperial Group etc.

-Despite the benefits of diversification, the recession of early 90s led to many firms to revert to some
more familiar ‘’core’’ businesses, thus only about 10% of new UK mergers in the 90s could be
classified as conglomerate mergers e.g. the de-merger of Hanson plc in 96 produced four businesses
with recognizable ‘’core’’ activities, namely tobacco, chemicals, building and energy.

-Economies of scope: efficiency gains from diversification [lecture/perhaps expand on this]

-4) Lateral Integration

-When the firms which combine are involved in different products, but in products which have some
element of commonality e.g. factor input, similar labour skills, capital equipment, raw materials,
product outlet etc. E.G. Swiss firm Tetra Laval’s offer for the French company Sidel.

-Results of theories based on motives for mergers have been inconsistent and contradictory. An
interesting survey article on merger activity in 89 noted that as many as fourteen separate motives
were frequently cited in the support of merger activity (Mueller, 1989).

-At the same time, there’s more influencing factors that motivate mergers.

Benefits Costs
-Static efficiency: economies of scale and -Monopoly: consumers are exploited and
improved productive efficiency (cost savings) resources misallocated-loss of economic welfare.

-Dynamic efficiency: increased profits can be
used for R&D into new products and new
production methods creating long term dynamic
efficiency; provides funds for capital investment.
-Capital markets: if unsuccessful mergers occur,
corporate raiders will kick out the unsuccessful
management (the share price will fall).
-Market contestability: potential competition
more important than market share
-Less competition: entry barriers may exist & the
efficiency savings of the merger may be less than
expected.
-Imperfect capital markets: unsuccessful
managers may stay in place.
-Job losses: cost-cutting and rationalization leads
to less employment.

-International competition: EU single market

leads to need for larger firms.
Economic Theory & Merger Activity

->The value discrepancy hypothesis

-Theory based on a belief that two of the most common characteristics of the industrial world are
imperfect information and uncertainty. Together, these help explain why different investors have
different expectations of the prospects for a given firm.

-The value discrepancy hypothesis suggests that one firm will bid for another only if it places a
greater value on the firm than that placed on the firm by its current owners. i.e. if Firm B is valued at
Va by Firm A & Vb by Firm B then a takeover will only take place if Va>Vb + costs of acquisition.

-The difference in variation arises through Firm A’s higher expectations of future profitability, often
because A takes account of the improved efficiency with which it believes the future operations of B
can be run.

-Arguably, when tech market conditions and share prices are changing most rapidly that past
information and experience are of least assistance in estimating future earnings.

-Hence, difference in valuation are likely to occur more often leading to increased merger activity
thus the hypothesis would predict high merger activity when technological change is most rapid and
when market and share price conditions are most volatile.

-There’s evidence eg. in the book

->The valuation ratio

-Valuation ratio=market value/asset value

=no. of shares x share price/ book value of assets

-If a company is ‘’undervalued’’ because its share price is low compared to the value of its assets,
then it becomes a prime target for the ‘asset stripper’.

-If a company attempts to grow rapidly it will tend to retain a high proportion of profits for
reinvestment, with less profit thus available for distribution to shareholders. The consequence may
be a low share price, reducing market value of the firm in relation to the book value of its assets i.e.
reducing the valuation ratio. Arguably, high valuation ratio will deter takeovers, whilst a low
valuation ratio will increase the vulnerability of the firm to takeover.

-When the valuation ratio is low and a company would appear to be a ‘bargain’, a takeover may
originate within the company; in this case it’s referred to as a management buyout (MBO).

-The valuation ratio ; whether high or low, could be a grand motive for mergers/takeovers. Here the
question could also could up of is the ratio more applicable to merges or takeovers.

-Evidence section in the book.

-> The market power theory

-Main motive behind merger activity may be to increase monopoly control of the environment in
which the firm operates. Instead market power may help the firm to withstand adverse economic
conditions, and increase long-term profitability.

-3 situations are likely to induce merger activity aimed at increasing market power:

1) Where a fall in demand results in excess capacity and the danger of price-cutting competition. In
this situation firms may merge in order to secure a better vantage point from which to rationalize
the industry.

2) Where international competition threatens increased penetration of the domestic market by

foreign firms. Mergers in electronics, computers and engineering have in the past produced
combines large enough to fight off such foreign competition.

3) Where a tightening of legislation makes many types of linkages between companies illegal. Firms
have in the past adopted many practices which involved collusion in order to control markets. Since
restrictive practices legislation has made many of these practices illegal between companies,
merger, by ‘internalizing’ the practices, has allowed them to continue.

-Hence, mergers may take place to increase a firm’s market power. The act of merging usually
results in increase in company size, in absolute terms and relation to other firms. Hence, the
increased size will be a by-product of the quest for increased market power and itself a cause of
increased market power.

-A study found that 48% of all mergers estimated that the motive was risk reduction, to control
markets along the lines of market power theory.

-Empirical work does suggest that an increase in the size of a firm raises its market power e.g. large
firms often experience less variability in their profits than small firms, indicating that large firms may
be less susceptible to changing economic circumstances as a result of their greater market power.

-Size, stability and market power are closely interrelated. Also, profitability and market power are
closely related. Motive for mergers, surveys found that expectations of increased profitability are a
major reason of mergers/ takeover. Second most important motive, pursuit of market power.

-However, actual results don’t show actual evidence of any increase in market power that is effective
in raising firm profitability.

-> Economies of scale

-Achievement of lower average costs (thereby higher profits) through an increase in the sale of
operation is the main motive for merger activity.

-Plan and firm-level economies might add the ‘synergy’ effect of merger, the so-called ‘2+2>4’ effect,
whereby merger increases the efficiency of the combined firm by more than the sum of its parts.
Synergy could result from combining complementary activities as , for e.g., when one firm has strong
R&D team whilst another firm has more effective production control personnel.

-Big motive for merger activity is pursuit of marketing economies of scale. Although recent EU
annual reports on competition policy seem to indicate that the synergies to be derived from
‘combining complementary activities’ are an important motive for merger activity, this reason was
also ranked well behind ‘strengthening of market share’ and ‘expansion’.
-It is possible that, economies of scale as a rationale for mergers might also be linked to the cyclical
patterns of demand. E.G. increased benefits of size in industries in which economies of scale matter
often drive mergers around cyclical patterns, which firms seeking to grow larger and benefit from
economies of scale when they expect demand to be high and rising (Lambrecht, 2004).

-> Managerial theories

-The underlying principle in merger activity, the pursuit of profit.

-e.g. market power theory suggests that through control of the firm’s environment, the prospects of
profits, at least in the long run, are improved.

-economies of scale theory concentrates on raising profit through the reduction of cost.

-managerial theories, on the other hand, lay hreater stress on non-profit motives.

-With the increase of public limited company there has been progressive divide between ownership
by shareholders and control by management. This has given managers greater discretion in control
of the company, and thus in merger policy.

-In these theories the growth of the firm raises managerial utility by bringing higher salaries, power,
status, and job security to mangers. Managers may therefore be more interested in the rate of
growth of the firm than in its profit performance.

-Managerial theories suggest that fast-growing firms, having already adopted a growth-
maximisation, are the ones most likely to be involved in merger activity. These theories would also
suggest that fast-growing firms will give higher remuneration to managers, and will raise job security
by being less prone to takeover.

-The acquiring companies had much higher growth rate than the acquired firms, and possessed
many of the other attributes of a growth maximizer, such as a higher retention ratio, higher gearing
and less liquidity.

-Another possible motive, higher managerial remuneration through growth, results in significant
increase in the salaries of directors of the acquiring company after merger.

-Much faster growth than organic growth.

Impact of -In the short run, the profit level often deteriorates for the acquiring firms is taken by
some as further evidence in support of the managerial approach. Firms involved in mergers tended
to have lower profitability levels than non-merging firms. At the same time, large firms, even if not
the most profitable, are less likely to be taken over than small to medium-sized firms.

-Impact of -Once firms become large they appear to be more ‘stable’ and less prone to takeover.
Such evidence is consistent with managerial theories which stress the security of managers. It should
also be noted that the merger boom of late 80s showed that even large firms were no longer safe
from takeovers; in part due to firms now having easier access to the finance required for takeover
activity.

-Motive: evidence points away from traditional economies of scale. More so, towards survival of the
firm and control of its environment, main reason for most merger activity. Hence, usually means the
sacrifice of profit, at least in the short run. Such observation is consistent with market power and
managerial theories.
-> Mergers and the public interest

-The resulting growth in firm size will have implications for the ‘public interest’.

-‘’Before a more detailed investigation into the legislation and institutions involved in regulating
merger activity in the UK, EU and US, it may be helpful to consider the potential aspects of a merger
on economic efficiency and economic welfare, which are two key elements in any definition of the
‘public interest’. ‘’

-> Economic Efficiency

-Idea of economic efficiency may usefully be broken down into two separate elements:

1) Productive efficiency: using most efficient combination of resources to produce a given level of
output. Only when the firm is producing a given level of output with the least-cost methods of
production available do we regard it as having achieved ‘productive efficiency’.

2) Allocative efficiency : setting a price which corresponds to the marginal cost of production.
Consumers pay firms exactly what it costs them to produce the last (marginal) unit of output; such a
pricing strategy can be shown to be a key condition in achieving a so-called ‘Pareto optimum’
resource allocation, where it’s no longer possible to make someone better off without making
someone else worse off. Any deviation of price away from marginal cost is then seen as resulting in
‘allocative inefficiency’.

-A possible issue for policymakers is that the impacts of proposed mergers may move these two
aspects of economic efficiency in opposite direction. E.g. economies of scale may result from the
merger having increased firm size, with a lower cost of producing any given output thereby
improving productive efficiency.

-But, the greater market power associated with increased size may give the enlarged firm new
opportunities to raise price above (or still further above) its costs of production, including marginal
costs, thereby reducing allocative efficiency.

-May need to balance the gain in productive efficiency against the loss in allocative efficiency to get a
better idea of the overall impact of the merger on the ‘public interest’.

-> Economic Welfare

-A branch of economics which often involves ideas of consumer surplus and producer surplus.

-Consumer surplus: benefit to consumers of being willing to pay more for a product than they
actually have to pay in terms of the going market price. Usually measured by the area underneath
the demand (willingness to pay) curve and above the ruling market price. If the ruling market price is
P and quantity sold Q, then are afd corresponds to the ‘consumer surplus’, i.e. consumers are willing
to pay OafQ for Q units, but only have to pay OdfQ (price x quantity), giving a consumer surplus of
afd.
-For simplicity, we assume that the curves to be linear, and the firm to be at an initial price/quantity
equilibrium of P/Q with marginal cost MC (for a profit-maximizing firm MR would have intersected
MC at point i). Now, when the merger/ takeover results in the (enlarged) firm ^2 using its market
power to raise price from P to P1, cutting output from Q to Q1, but that at the same time the newly
available scale economies cut costs so that MC sifts downwards to MC1.

-We have to balance a loss of allocative efficiency against a gain in productive efficiency to assess the
overall impact on the ‘public interest’. Can usually return to the idea of economic welfare, and the
associated consumer and producer surpluses.

-if we regard the total welfare resulting from a resource allocation as being the sum of the consumer
surplus and the producer surplus, we have: 1) pre-merger: afd + dfig; 2) post-merger: abc + bckj;

-In terms of total welfare (consumer surplus + producer surplus) we can note the following
impacts of merger: 1) gains of welfare: ghkj; 2) loss of welfare: cflk;

-The ‘gain of welfare’ (ghkj): improvement in productive efficiency from the merger, as the Q1 units
still produced require fewer resources than before, now that the scale economies have reduced
costs (shifting MC down to MC1).

-The ‘loss of welfare’ (cflk): deterioration in allocative efficiency from the merger; price has risen (P
to P1) and marginal costs have fallen (MC to MC1), further increasing the gap between price and
marginal cost. As a result of the price rise from P to P1, output has fallen from Q to Q1. This loss of
output has reduced economies welfare, since society’s willingness to pay for these lost Q-Q1 units
(area under the demand curve from Q-Q1, i.e. cfQQ1) exceed the cost of producing them (the sum
of all marginal costs from Q-Q1, i.e. klQQ1) by cflk.
-The overall welfare effect (‘public interest’) could be positive or negative, depending on whether
the welfare gains exceed the welfare losses, or vice versa. Much depends on the extent of any price
rise and on the demand and cost curve configurations for any proposed merger.

-Hence, it’s in this context that a Competition Commission (CC) investigation and other methods of
enquiry into particular proposals might be regarded as important in deciding whether any merger
should proceed or be abandoned.

-> Merger booms

-The most notable features which have tended to galvanize merger and takeover activity have often
included the following:

1) The growth of national and international markets has created circumstances favourable to
economies of scale, while at the same time world tariff barriers have been reduced under the
guidance of GATT (now the WTO). The result has been fierce competition between nations which
has often led to a rationalization of production since larger firms have been seen as having important
cost advantages.

2) Improved communications methods, often involving information/ telecommunication

technologies, have made it easier for large companies to grow, while the adoption by many
companies of a multidivisional structure has encouraged horizontal mergers.

3) There has been a rapid growth in the number and type of financial intermediaries, such as
insurance companies and investment trusts. They have begun investing heavily in company equity,
thereby providing a ready source of finance for companies who want to issue more shares and then
to use the money received to support a takeover bid.

-The ‘divorce of ownership from control’ has made takeover activity easier because directors now
have a less close relationship with the company, and are thus less committed to its continuing in an
unchanged form.

4) Many of the periods of intense merger activity have seen an increase in the ‘gearing ratio’ of
companies i.e. an increase in the ratio of debt (debenture and bank borrowing) to shares (equity).
Loan finance has proven attractive because the interest paid on debentures and loans has been
deducted from company profits before it’s taxed. Thus, firms have had a tax incentive to issue loan
stock, the money from which they have then been able to use to mount a takeover bid.

-Motives of mergers of 1985-89 were of horizontal type- hence, production economies arising from
rationalization [look into the external factors PESTLE perhaps, why was this the case during this time
period]. This motive has been derived from the desire to integrate technology and improve
marketing to integrate technology and to improve marketing expertise to increase market power.

-Motive for acquired and acquiring firms: Also there’s evidence that target companies in this period
tended to be less dependent on debt finance, which suggests that some acquisitions may have been
due to the desire of the acquirer to increase cash flow and to reduce its dependency on debt
finance. Also, during this period mergers were largely financed by share issues.

-After the stock market crash in late 1987, the decrease in share prices and the rise in interest rates
meant that takeovers increasingly involved cash deals rather than share issues.

-Merger and acquisition activity during 1992-2009 has been triggered by many factors, including
merger opportunities in utilities such as electricity and water, and attempts to secure greater market
share in the pharmaceutical, telecommunications and finance industries to gain scale economies and
provide a base for global expansion. There are a few egs. In the book online.

-Another feature of the merger trends of the last 35 years is the increasing importance of cross-
border acquisitions as a proportion of all mergers involving UK firms. The Single Market and the
greater integration of the EU, together with the effects of globalization noted previously, have
provided a platform for greater involvement by UK firms in international acquisitions.

-> The control of mergers and acquisitions

-Mergers may be a means of extending market power.

-The UK experience

-UK legislation has been tentative in its approach to merger activity, recognizing the desirable
qualities of some monopoly situations created through merger; hence, seeks to examine each case
on its individual merits.

-First UK legislation, the Monopolies and Restrictive Practices (Inquiry and Control) Act, dates from
1948 and set up the Monopolies Commission. The power of 1948 Act was extended to mergers by
the Monopolies and Mergers Commission (MMC) could now report on situations where a merger
resulted in a combined market share of 25% or more of a particular good or service, or involved
combined assets of over £30m.

-Next major Act having implications for merger activity was the Fair Trading Act 1973, under which
Office of Fair Trading (OFT) was formed with a Director-General of Fair Trading (DGFT) as its head.
Over the next quarter of a century, the DGFT advised the Secretary of State for Trade and Industry as
to which mergers should be referred to the MMC for investigation.