The Future of M&A

Mergers and acquisitions are, to say the least, big business, even in today’s hard times. Deal flow in a slow [...]

October 8 2008 by Richard A. Epstein


Mergers and acquisitions are, to say the least, big business, even in today’s hard times. Deal flow in a slow second quarter still came close to $1 trillion on just under 9,000 deals worldwide. Those totals look paltry only in comparison to results for the same period in 2007: about 9,600 deals fueling over $1.5 trillion in revenues. Hardly chicken feed.

A market that vast is fueled by the strong belief that these transactions make sense for all their many participants. Acquiring companies is not exactly buying a sack of potatoes at the local supermarket. Yet, these two disparate transactions share one overriding feature. No one enters any deals without the prospects of gains. Figuring out whether Large Co. should buy Small Co. or merge with Middle Co., however, is a complex matter. The very deals that promise huge synergies can shipwreck during negotiation, falter through sloppy execution or scuttle bad morale if cultural differences between firms are not attended to. Remember this not-so-old joke: How do you pronounce DaimlerChrysler? Answer: Daimler; the Chrysler is silent. A 1998 dream merger of dreams was undone by a sale of Chrysler to Cerberus Capital Management in 2007.

These critical business judgments are not stuff for the lawyer’s regulatory mill. CEOs generate great deals. Their lawyers are duty bound to identify legal risks. Deciding whether these are deal killers, or navigating them if they are not, is no small task. The job becomes ever more difficult in a global environment where each nation in which any of the companies do substantial business has to bless the deal. Paperwork is the minimum cost. Different legal cultures in the U.S. and the EC can also kick in. 

Antitrust Issues

On some large transactions, it’s easy to spot differences, especially in the approach to antitrust (or, in EC speak, competitions) policy. CEOs were right to raise eyebrows when the EC torpedoed the GE/Honeywell merger that had already sailed through the U.S. Department of Justice. But cases like that are few and far between. The good news is that in most markets where business players enter and leave the stage at dizzying speed, U.S. and EC regulatory authorities are reasonably savvy. In fact, a quick look at the second-quarter 2008 mergers reveals none in which antitrust concerns loom large.

In the U.S., the era of good sense toward mergers dates back at least to 1992, when the Department of Justice and the Federal Trade Commission published their Horizontal Merger Guidelines. The word “horizontal” signals that the federal government has wisely decided to throw in the towel on vertical mergers, that is, those that bring under common management firms that control different stages of the production process. These mergers tend to remove the bottlenecks from running a business and thus are widely regarded as cost-reducing and procompetitive. Conglomerate mergers rarely raise antitrust concerns, and present no peril to competition. Horizontal mergers, however, offer a complex mixture of efficiency gains and monopoly losses due to excessive concentration. The latter risk is tiny in virtually all cases except megamergers, to which the U.S.‘s Merger Guidelines rightly direct all its fire.

It was not always thus. In the 1960s the feds thought any transaction was fair game for an antitrust challenge if it reduced the number of mom and pop stores. Exhibit A is United States v. Von’s Grocery, a 1966 Supreme Court special that blocked the acquisition by the third-largest grocery chain of the sixth-largest chain in Los Angeles, when both firms had a combined market share of 7.5 percent.

Even with a standard concentration measure, the Herfindahl-Hirschman Index, of barely over zero, the Justice Department blocked the merger on the dubious theory that two tiny firms would be more dynamic than one small one. Today, only mergers that reduce the number of firms in a market from five to four get scrutiny. Hostility sets in at a three-to-two merger.

All this makes good sense because antitrust law should never degenerate into a misguided form of industrial policy, where government officials seek to pick winners and losers. All in all, antitrust issues generally have little traction in today’s M&A world.

Securities Law

A second source of legal peril is that the securities laws are more insistent. The general prohibitions against insider trading do not apply solely to mega – mergers. Any deal involving a public corporation will attract an eager bevy of litigators if any stray word or diplomatic silence is thought to move the market in connection with the purchase or sale of any security. The broad definition of “manipulative and deceptive devices” under Rule 10-b-5 of the 1934 Securities and Exchange Act can lead to heavy liabilities in any transaction. Those who lose from the market movement can sue the corporation, while those on the other side of the deal get to keep their winnings. The upshot is massive overdeterrence. A sensible legal regime would bar virtually all these private rights of action for unaccounted price swings. In its place, Congress should require modest fines for any material violations of the insider trading laws, which better match the small overall social loss.

As that sensible reform is not on the horizon, how can CEOs monitor the relevant risks? They are modestly helped by passage of the Private Securities Litigation Reform Act of 1995, which somewhat blunted the threat of class actions. But self-help is in general the best protection; CEOs, boards and spokespeople must learn to bite their tongues in a period of self-imposed quiet. These laws are a major irritant, but also a manageable risk that should not shipwreck any merger.

Sovereign Wealth Funds

Oddly enough, in these troubled times, a new regulatory threat looms by tightening possible regulation of the activities of Sovereign Wealth Funds, many of which boast coffers bursting with huge revenues from the sale of oil and other natural resources. Hint: SWFs will not go away. These funds currently clock in at between $2 trillion and $3 trillion, with more on the way. They dwarf the private equity sector in the U.S. They have the liquidity needed to make deals, both large and small, go. In an age in which mergers and takeovers may be crucial for the survival of many firms, this source of capital could prove invaluable.

Security risks could be involved if foreign nations use their investments to pry out military secrets. But these concerns have been addressed successfully by other legislation, most notably the Exon-Florio Act that authorizes the president to nix on national security grounds transactions that give foreign control to sensitive businesses.

The new generation of claims against SWF stems from a fear, shared by such notables as Christopher Cox, chairman of the SEC, and Lawrence Summers, former Secretary of the Treasury, that these firms will not abide by the capitalist creed of seeking to maximize profits in investing their funds. And so they might. But all sorts of unions and activist groups have similar designs on corporate policy. Think of the recent demands by the Service Employees International Movement that the California Public Employees Retirement System invest in companies that adhere to its preferred labor and environmental standards. Deep capital markets are largely impervious to these threats, as others can have a field day trading against firms with exotic social agendas.

However, all this is heated speculation. Moreover, the SWFs have been relatively timid in their financial dealings, perhaps out of fear of the public spotlight if they take any controversial stance. There is no evidence that the existing set of antitrust and securities laws are insufficient to deal with some nightmare scenario whereby a foreign nation seeks to buy up all the oil and gas leases in the U.S. And if something weird does happen, we could have far better information on how to respond.

In the short run, therefore, various proposals to require SWFs to meet special disclosure or governance requirements smacks more of a nervous protective imperialism than an effort to improve the efficiency of capital markets. If our M&A markets are to work well, we should not pile on special regulations that will drive these funds from our shores. We already have Sarbanes Oxley in place. Why court additional trouble? The marketplace is the best arena in which to sort through the welter of big corporation transactions. Law should facilitate these deals, not throw stumbling blocks in their path.


Richard A. Epstein is the James Parker Hall Distinguished Service Professor of Law at the University of Chicago, the Peter and Kirsten Bedford Senior Fellow at the Hoover Institution, and the author of Supreme Neglect: How to Revive Constitutional Protection for Private Property.