The Bear’s Lair: Most mergers should be stopped, not waved through.

The Biden Administration’s Lina Khan, head of the Federal Trade Commission, is one of the administration’s very few bright spots, intellectually speaking. She has overthrown the existing merger jurisdiction, set up by the late great Judge Robert Bork in the 1980s, to question why the FTC should let through mergers as a matter of course. It is a very good question; countless studies have shown that most mergers destroy value rather than enhancing it, reliably enriching only the top managements of the companies concerned. Should the default position not be to ban mergers, and how different would the world look if we followed that approach?

The National Bureau of Economic Research produced a seminal paper in 2003, showing that over the previous 20 years, large companies had destroyed at least $226 billion in wealth through mergers and acquisitions. Only smaller companies had created wealth through mergers — $8 billion over the same period – thus, on balance, mergers had been highly value-destructive. Subsequent studies have confirmed this qualitative conclusion; indeed, during the “funny money” period of 2011-21, in which interest rates were held far below their market level and the incentives to undertake mergers were increased by the greater stock-option returns available to managements, that value destruction almost certainly increased geometrically.

In an ideal world, there would be no regulation of mergers. We do not however live in such a world; in an ideal world, we would be on a Gold Standard and share prices would be around a third of their current level, since there would be no inflation of asset prices through Fed money printing. In such a world, the incentive to merge companies would be limited to the few cases in which such mergers brought genuine operational or marketing synergies. The whole artificial apparatus of M&A brokers, private equity funds and leveraged buyout speculators would disappear. (It must after all be remembered that the first contested takeover in the United States was the international Nickel deal, which took place as recently as 1974.)

We do not, however, live in such a world. Even two years after the end of the worst “funny money” policies, stock and asset prices remain artificially high, and the return on acquiring new assets correspondingly low, although the possibility of speculative gains will always attract the private equity crowd. In the world we actually inhabit, there are few natural constraints on excessive, economically unproductive mergers, and so it may make sense to introduce an artificial one, in the form of Khan’s FTC.

It probably does not make sense to ban mergers altogether – the rare cases where a competitor takes over a failing medium sized company and rescues it are on balance worth preserving. It certainly doesn’t make sense to permit mergers only via the kind of “woke” criteria Ms. Kahn and her colleagues are likely to dream up – an undertaking to employ more transgenders or use appropriate pronouns at board meetings is unlikely to distinguish a good merger from a bad one. Nevertheless, a general prohibition against mergers, with an FTC office full of very old-fashioned bean-counter types determining which few special cases would be allowed through, might well be economically superior to the fees-and-stock-options driven casino we have currently.

Such a system would sharply reduce the concentration in most industries, producing business sectors where many medium sized companies competed, mostly having stable employment and an informally-agreed “who does what” division of the markets concerned. Such a structure would have several advantages over what we have now:

  • With fewer mergers, every industry would have more competitors and be more competitive. Prices of many items would be lower, because the fiercer competition would prevent companies from raising prices and spending the money on stock buybacks, excessive CEO compensation and bureaucracy.
  • With almost no mergers permitted, the incentive to arrange mergers to boost both managements’ stock option value would disappear. This would produce a vast saving in the brokers, leveraged buyout artists, PR people and lawyers currently employed producing mergers, a big net gain to the economy.
  • Since there would be no behemoth companies (after a transition period of perhaps a decade) there would no longer be any excuse for excessive management remuneration, and no possibility of disguising the dilution from excessive stock options grants. There would be far fewer stock buybacks also; a medium-sized company that buys back all its stockholders’ equity becomes toast in the next downturn, with no possibility of the kind of taxpayer bailout that GM received in 2009.
  • Even without a transition to sensible monetary policy, the stock market would become less overvalued. There would be no “Magnificent Seven” – since those behemoths would not have been allowed to buy all their competitors, their component parts would form an Intermittently Magnificent Seven Hundred.
  • The working lives of the unfortunates below the top management level would be greatly improved and much more secure. There would be no mergers causing massive layoffs, and no megalomaniac managers trying to build empires at the expense of their employees and stockholders. Most of the larger companies would generally have employment numbers in the 1,000-5,000 employee range, making them much more human and pleasanter to work for, especially for “middle managers” for which there would be huge demand because of the plethora of corporate entities.
  • Objectors will claim that this proposal would increase costs and reduce U.S. competitiveness, since there would be no way to form the very large “General Motors” type companies with huge economies of scale. However, with computer-aided manufacturing, let alone AI-aided techniques, the economies of scale are simply not there. The only companies today that might benefit from 100,000 employees are those like McDonalds and Coke where intensive localized distribution is needed. However, there are few benefits to consumers in terms of quality or cost in a McDonalds versus a regionally branded burger chain; indeed regional burger chains such as Texas’s Whataburger have shown themselves well able to out-compete McDonalds in their markets, by catering to subtle regional taste differences.
  • Consumer choice will be greatly enhanced, since for all products and services there will be many well-established competitors, that will not be absorbed into the behemoths. This will allow for product differentiation as a competition strategy, with companies competing on quality and features as well as shelf space and advertising. In those few cases where market share is currently necessary, such as airlines where the ability to offer a “through” service is important, it would doubtless be possible to enter code-sharing arrangements to maximize the number of routes offered — the “bean-counters” at the FTC could usefully employ their energies on ensuring that those arrangements did not produce the ill effects of mergers.
  • Finally, if the largest companies disappeared, and medium-sized companies dominated the landscape of most businesses, the huge disadvantages for entrepreneurs of competing against the behemoths would disappear. Network effects, so impenetrable a barrier to new entrants to a tech market, themselves being ephemeral as technology advances, would over time disappear or be shared by all participants in a market. In such a situation, the market playing field would finally be levelled, and individuals and small family-owned businesses would be able to flourish. As history has shown, innovation would be greatly accelerated by such a change.

Ever since William McKinley gave the green light to the “trusts” in 1897, after the Sherman Anti-Trust Act of 1890 had appeared to forbid them, the U.S. economy has worked on the basis that “bigger is better.” The resulting tsunamis of mergers have produced an economy where diseconomies of scale dominate in many sectors, while the original economies of scale that caused the mergers have disappeared. Given the excessive incentives for top managements to merge, we cannot rely on the economy to “sort itself out.” Ms. Khan’s approach, in which mergers would be forbidden except in a very few cases, would almost certainly make us richer in the long run.

I have no doubt at all that it would make us happier.


(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)