COMPETITIVE EFFECTS OF PARTIAL OWNERSHIP

Steven C. Salop Georgetown University Law Center

EXAMPLES OF PARTIAL OWNERSHIP MATTERS

Dairy Farmers of America
Media Comcast NBCU

Airlines
Northwest-Continental Pipelines

NewsCorporation DirecTV
Univsion -Hispanic Broadcasting

Questar-Kern River
Kinder Morgan US Govt Guidelines

Primestar
Time Warner-Turner

Competitor Collaboration Guidelines (2000)

HMGs (2010)

AREEDA-TURNERS CHALLENGE
A non-controlling acquisition has no intrinsic threat to competition at all.
Unfortunately, there is no formula that can describe the likelihood of such effects... Inappropriate, for example, would be a formula that attempted to discount market shares...according to the acquirers shareholding. [T]here is no reason to suppose that the effects of lesser acquisitions are in any way proportional to shareholdings.
Source: Treatise, vol. V (1980) at para. 1203

UNPACKING PARTIAL OWNERSHIP

Financial Interest
Entitlement to Share in Profits from Asset

Control
Entitlement to Choose How Asset Is Used

Financial Interest and Control Are Separable and Distinct Attributes of Ownership

Financial Interest and Control Have Separable and Distinct Competitive Effects
Joint Ventures Involve Multiple Partial Ownership Interests and Control (Governance) Rules

IMPACT OF PARTIAL OWNERSHIP ON PRICING INCENTIVES

Suppose that Owner of Firm-A Has a Partial Ownership Interest in Firm-B
Financial Interest: Affects Pricing Incentives of Firm-A Control: Affects Pricing Incentives of Firm-B

EFFECT OF FINANCIAL INTEREST ON As PRICING INCENTIVES

Suppose that Owner of Firm-A Purchases a Non-Controlling, Passive 25% Financial Interest in Firm-B
Assume Unilateral Conduct Owner of Firm-A Takes into Account its Share of Firm-Bs Profits in Setting its Price
Maximize Profits of Firm-A + 25% x Profits of Firm-B

Thus, Firm-A Increases Unilateral Incentive to Raise Price, Relative to No Financial Interest

TECHNICAL ANALYSIS: BALANCING GAINS AND LOSSES FROM RAISING PRICE

If No Financial Interest in Firm-B
Gains: Higher Margin On Maintained Volume Losses: Lost Customers Reduce Profits

Impact of Non-Controlling, Passive Financial Interest on Profitability Calculation

Additional Gains: Some Fraction of Lost Customers Switch to Firm-B, Raising Firm-Bs Profits Owner of Firm-A Recpatures a Share of These Higher Profits

Implication: Financial Interest in Firm-B Increases Unilateral Incentive to Raise Price of Firm-A

IMPACT OF CONTROL ON FIRM-Bs PRICING INCENTIVES

Firm-As Financial Interest in Firm-B Does Not By Itself Lead the Managers of Firm-B to Change Price
Firm-Bs Managers Would Have the Continued Incentive to Maximize Solely the Profits of Firm-B But, If Owner of Firm-A Also Would Control FirmB or Firm-Bs Managers, It Would Have the Incentive to Raise Firm-Bs Price Incentive Effects Depend on Degree of Control

CONTROL SCENARIOS: FIRM-As CONTROL OVER FIRM-B

Zero Control (Silent Financial Interest)
Total Control Partial Control and Influence
Fiduciary Obligation Joint Control Proportional Control One-way Control

SILENT FINANCIAL INTEREST

Owner of Firm-A Has No Control over Firm-B
Non-Voting Stock Small, Minority Interest Voting Trust ??

Firm-B Managers Objective: Maximize Stand-Alone Profits of Firm-B Implication: Silent Financial Interest Does Not Directly Cause Firm-B to Raise Price But -- Increase in Firm-As Price May Lead to Indirect Increase in Prices of All Competitors, Including Firm-B

TOTAL CONTROL
Owner of Firm-A Has Complete, Unconstrained Control over Firm-Bs Price
Owners Objective: Maximize Profits of Firm-A plus Firm-As Share of Firm-Bs Profits Implication: Firm-B Raises Price in Order to Increase the Profits of Firm-A

PARADOX OF TOTAL CONTROL

Lower Financial Interest Leads to Higher Price
Free Rider Problem of Total Control
Raising Firm-Bs Price Decreases Firm Bs Profits Raising Firm-Bs Price Increases Firm-As Profits

Owner of Firm-A Weights Conflicting Effects According to Relative Financial Interest Shares in the Two Firms

Example of Miniscule Financial Interest with Total Control of Firm-B Smaller Financial Interest in Firm-B Gives Owner of Firm-A Greater Incentive to Raise Price of Firm-B

Ownership Consolidation Can Reduce Prices

PARTIAL CONTROL AND INFLUENCE SCENARIOS

Fiduciary Obligation
Joint Control Proportional Control One-Way Control

FIDUCIARY OBLIGATION
Corporate Law: Firm-Bs Board Has Fiduciary Obligation to Act in the Best Interest of Minority Shareholders
Constraint Could Lead to Silent Financial Interest Outcome Controversy over Strength of Fiduciary Obligation Constraint Antitrust (Section 1) Can Create Similar Constraints

JOINT CONTROL
Managers of Both Firms Serve Interests of Joint Shareholders -- They Set Both Prices to Maximize Joint Profits of Firm-B plus Firm-A
Requires Side Payments or Initial Lump-sum Compensation to Firm-B Shareholders
Stability/Opportunism Issue

Replicates Merger Outcome Higher Price than Zero Control Section 1 Antitrust Exposure -- Spillovers

PROPORTIONAL CONTROL
Firm-Bs Managers Choose Price to Balance Interests of Owners in Proportion to Their Financial Interests in Firm-B
But, Firm-As Managers Maximize Profits of FirmA plus Interest in Firm-B Outcome Could Exceed or Fall Short of Merger, Depending on Financial Interests

ONE-WAY CONTROL
Managers of Firm-B Serve Combined Interests of All Shareholders: They Set Price of Firm-B to Maximize Joint Profits of Firm-B plus Firm-A
Role of Side Payments

But, Firm-As Managers Maximize Profits of FirmA plus Interest in Firm-B

Higher Price Incentive than Zero Control Lower Price Incentive than Total Control

ANALYSIS OF JOINT VENTURES

Joint Venture as Multiple Partial Ownership Interests
More Complex Governance Issues

Total Control in Horizontal Joint Ventures

Potentially Dysfunctional Outcome Merger Among 2 Owners Can Improve Outcome

Fiduciary Obligation Outcome May Be Superior Corporate Charter May Require Fiduciary Obligation

MEDIAN VOTER THEORY

Median Voter Has Total Control in Simple Models
Median Voter May Have Small Ownership Share, Leading to Potentially Dysfunctional Outcome

Non-Existence of Median Voter Equilibrium With Multiple Issues Agenda Control: Power Constrained by Independent Directors and Corporate Charters

QUANTIFYING COMPETITIVE IMPACT

Cournot Model -Modified HHI (MHHI)

Bertrand Model -- Modified GUPPI

MODIFIED HHI (MHHI)

MHHI Roughly Gauges Combined Incentive Effects of Financial Interest plus Control
HHI and MHHI Can Be Formally Derived from Cournot Model of Unilateral Conduct Compare MHHI Deltas to Estimate Competitive Effects of Partial Ownership

Alternative Estimates for Differentiated Products Derived from Bertrand Model of Unilateral Conduct

MHHI DELTAs
= As Financial Interest in Firm-B

Full Merger: Silent Financial Interest: Total Control: Joint Control:

= 2SaSb = SaSb = ( + 1/) SaSb = 2SaSb

NUMERICAL EXAMPLE
Firm-As Market Share = 20%
Firm-Bs Market Share = 10% Firm-As Financial Interest in Firm-B = 20%

Merger/Joint Control: Silent Financial Interest:

= 400 = 40

Total Control:

= 1200

MODIFIED GUPPIs (mGUPPI)

Based on Bertrand Differentiated Products Model
Unilateral Pricing Incentives (No Tacit Collusion) Example: Silent Financial Interest Acquiring firm-1: mGUPPI1= GUPPI1 = DR12 M2 x P2/P1 Acquired firm-2: mGUPPI2 =0

= firm-1s equity interest in firm-2

MODIFIED GUPPIs Multipliers for GUPPIs

mGUPPI a Full Merger: 1 mGUPPIb 1

Silent Fin. Interest

Total Control: Joint Control:

0
1/ 1

EXTENSIONS
Complex Cross-Ownership Patterns/Interlocks
Efficiencies Minority Interest Discounts