Ever wondered why competition regulators in both Canada and the US sometimes put the brakes on M&A deals? As mature markets become increasingly concentrated while smaller players are bought out and entities merge to achieve greater economies of scale, we continue to see headlines featuring the involvement of competition regulators in M&A transactions. But if we value the concept of 'free markets,' why are governmental bodies involving themselves in private transactions?
Adam Smith, one of the earliest proponents of modern capitalism, was a strong supporter of competition (antitrust) law. In his Inquiry Into the Nature and Causes of the Wealth of Nations, he wrote, "The Monopolists, by keeping the market constantly understocked, by never fully supplying the effectual demand, sell their commodities much above the natural price, and raise their emoluments, whether they consist in wages or profit, greatly above their natural rate." As companies merge and markets become more concentrated, the absence of competition may allow those who dominate markets (the monopolists) to charge prices above what prices would be in in a state of perfect competition. But how do we distinguish a beneficial M&A transaction from one that could lessen competition?
In assessing a firm's involvement in an anticompetitive merger (Competition Act, s 92) the power of a firm to influence a market is relevant since "lessening of competition results only from .... exercise [of] market power" (Merger Enforcement Guidelines (MEGs), s 2.1). In order to assess the market power of a firm, regulators must first define the market in which the firm is said to have power. The idea of a is a relative concept that can be construed broadly (as in the expression "the Market") or narrowly (as in 'the market' for coffee mugs).
For the purpose of competition law, the idea of a market hinges on the concept of substitutes since "the outer boundaries of a product market are determined by the reasonable interchangeability of ... the product itself and substitutes for it" (Brown Shoe Co v United States). Regulators, then, may define a given market broadly enough to encompass a product and its substitutes but narrowly enough to exclude products that are not true substitutes.
One simple way to refine the definition of a market (apart from the rigorous economic analysis often connected with competition law) is to apply what is termed the 'hypothetical monopolist test'. This approach suggests that a relevant market is the smallest collection of products in respect of which a hypothetical monopolist (HM) would find it profitable to impose a small but significant and non-transitory increase in price (SSNIP). According to s. 4.3 of MEGs, a SSNIP may be construed as a 5% increase for the duration of one year but "depends upon the nature of the industry" (see Horizontal Merger Guidelines, US DOJ and FTC). If the HM would not be able to impose a SSNIP then the relevant market (to competition law anyway) must be construed more broadly. After construing the market more broadly, the test is reapplied and repeated until a SSNIP may be imposed, at which point the market has been properly construed.
Once the relevant market has been construed, in deciding whether a merger or acquisition should be allowed, regulators will consider whether the transaction will or likely will prevent or lessen competition substantially in that market (Competition Act, s. 92(1)). Here substantial lessening and substantial prevention are similar with respect to their economic effects, but the prospectiveness of competition law is underscored by the concept of prevention. The idea of substantiality, though not defined in the Competition Act, is understood as creating, maintaining or enhancing a firm's ability to exercise market power – and this enhancement of power must be substantial since "some lessening of competition following a merger is tolerated" (Canada v Southam Inc.). These rules are applicable to trades, industries and professions as well as sources and outlets pertaining to such (Competition Act, s 92(1)(a-d)). If competition may be limited or prevented, then regulators may prohibit a merger or acquisition.
There are many more wrinkles to competition law in Canada that can be explored in the Merger Enforcement Guidelines found on the Competition Bureau's website.
The author would like to thank Alan Hounsell, articling student, for his assistance in preparing this legal update.
Norton Rose Fulbright Canada LLP
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