the repos were undertaken just prior to the end of a calendar quarter, their financial statements looked better
than they actually were.
The firm’s outside auditing firm, Ernst & Young, was aware of the moves but continued to pronounce
the firm’s financial statements to be in accordance with generally accepted accounting principles. The SEC,
the recipient of the firm’s annual and quarterly financial statements, failed to catch the ruse. In the weeks
before the firm’s demise, the Federal Reserve had embedded its own experts within the firm and they too
failed to uncover Lehman’s accounting chicanery. Passed in 2002, Sarbanes-Oxley, which had been billed
as legislation that would prevent any recurrence of Enron-style accounting tricks, also failed to prevent
Lehman from “cooking its books.” As required by the Sarbanes-Oxley Act, Richard S. Fuld, Lehman’s
chief executive at the time, certified the accuracy of the firm’s financial statements submitted to the SEC.
When all else failed, market forces uncovered the charade. It was the much maligned “short–seller” who
uncovered Lehman’s scam. Although not understanding the extent to which the firm’s financial statements
were inaccurate, speculators borrowed Lehman stock and sold it in anticipation of buying it back at a lower
price and returning it to its original owners. In doing so, they effectively forced the long-insolvent firm into
bankruptcy. Without short-sellers forcing the issue, it is unclear how long Lehman could have continued
the sham.
A Federal Judge Reprimands Hedge Funds in their Effort to Control CSX
Investors seeking to influence a firm’s decision making often try to accumulate voting shares. Such
investors may attempt to acquire shares without attracting the attention of other investors, who could bid up
the price of the shares and make it increasingly expensive to accumulate the stock. To avoid alerting other
investors, certain derivative contracts called “cash settled equity swaps” allegedly have been used to gain
access indirectly to a firm’s voting shares without having to satisfy 13(D) prenotification requirements.
Upon taking possession of the shares, the hedge fund would disclose ownership of the shares. Since the
hedge fund does not actually own the shares prior to taking possession, it does not have the right to vote the
shares and technically does not have to disclose ownership under Section 13(D). However, to gain
significant influence, the hedge fund can choose to take possession of these shares immediately prior to a
board election or a proxy contest. To avoid the appearance of collusion, many investment banks have
refused to deliver shares under these circumstances or to vote in proxy contests.
In an effort to surprise a firm’s board, several hedge funds may act together by each buying up to 4.9
percent of the voting shares of a target firm, without signing any agreement to act in concert. Each fund
could also enter into an equity swap for up to 4.9 percent of the target firm’s shares. The funds together
could effectively gain control of a combined 19.6 percent of the firm’s stock (i.e., each fund would own 4.9
percent of the target firm’s shares and have the right to acquire via an equity swap another 4.9 percent). The
hedge funds could subsequently vote their shares in the same way with neither fund disclosing their
ownership stakes until immediately before an election.
The Children’s Investment Fund (TCI), a large European hedge fund, acquired 4.1 percent of the voting
shares of CSX, the third largest U.S. railroad in 2007. In April 2008, TCI submitted its own candidates for
ruling by the federal court established a strong precedent limiting future efforts to use equity swaps as a
means of circumventing federal disclosure requirements.
Discussion Questions
1. Do you agree or disagree with the federal court’s ruling? Defend your position.
2. What criteria might have been used to prove collusion between TCI and 3G in the absence of
signed agreements to coordinate their efforts to accumulate CSX voting shares?
Google Thwarted in Proposed Advertising Deal with Chief Rival Yahoo!
A proposal that gave Yahoo! an alternative to selling itself to Microsoft was killed in the face of opposition
by U.S. government antitrust regulators. The deal called for Google to place ads alongside some of
Yahoo!’s search results. Google and Yahoo! would share in the revenues generated by this arrangement.
The deal was supposed to bring Yahoo! $250 million to $450 million in incremental cash flow in the first
full year of the agreement. The deal was especially important to Yahoo!, due to the continued erosion in the
firm’s profitability and share of the online search market.
The Justice Department’s threat to block the proposal is a sign that Google can expect increased scrutiny
in the future. High-tech markets often lend themselves to becoming “natural monopolies” in markets in
which special factors foster market dominance by a single firm. Examples include Intel’s domination of the
microchip business, as economies of scale create huge barriers to entry for new competitors; Microsoft’s
preeminent market share in PC operating systems and related application software, due to its large installed
customer base; and Google’s dominance of Internet search, resulting from its demonstrably superior online
search capability.
Discussion Questions
1. In what way might the Justice Department’s actions result in increased concentration in the online search
business in the future?
2. What are the arguments for and against regulators permitting “natural monopolies”?
BHP Billiton and Rio Tinto Blocked by Regulators in an International Iron Ore Joint Venture
The revival in demand for raw materials in many emerging economies fueled interest in takeovers and joint
ventures in the global mining and energy sectors in 2009 and 2010. BHP Billiton (BHP) and Rio Tinto
(Rio), two global mining powerhouses, had hoped to reap huge cost savings by combining their Australian
iron ore mining operations when they announced their JV in mid–2009. However, after more than a year of
regulatory review, BHP and Rio announced in late 2010 that they would withdraw their plans to form an
iron ore JV corporation valued at $116 billion after regulators in a number of countries indicated that they
would not approve the proposal due to antitrust concerns.
BHP and Rio, headquartered in Australia, are the world’s largest producers of iron ore, an input critical
to the production of steel. Together, these two firms control about one-third of the global iron ore output.
The estimated annual synergies from combining mining and distribution operations of the two firms were
estimated to be $10 billion. The synergies would come from combining BHP’s more productive mining
capacity with Rio’s more efficient distribution infrastructure, enabling both firms to eliminate duplicate
staff and redundant overhead and BHP to transport its ore to coastal ports more cheaply.
The proposal faced intense opposition from the outset from steel producers and antitrust regulators. The
greatest opposition came from China, which argued that the combination would concentrate pricing power
further in the hands of the top iron ore producers. China imports about 50 million tons of iron ore monthly,
largely from Australia, due to its relatively close proximity.
Discussion Questions:
1. A “remedy” to antitrust regulators is any measure that would limit the ability of parties in a
business combination from achieving what is viewed as excessive market or pricing power. What
remedies do you believe could have been put in place by the regulators that might have been
acceptable to both Rio and BHP? Be specific.
2. Why do you believe the antitrust regulators were successful in this instance but so unsuccessful
limiting the powers of cartels such as the Organization of Petroleum Exporting Countries (OPEC),
which currently controls more than 40 percent of the world’s oil production?
Justice Department Approves Maytag/Whirlpool Combination
Despite Resulting Increase in Concentration
When announced in late 2005, many analysts believed that the $1.7 billion transaction would face heated
anti-trust regulatory opposition. The proposed bid was approved despite the combined firms’ dominant
market share of the U.S. major appliance market. The combined companies would control an estimated 72
percent of the washer market, 81 percent of the gas dryer market, 74 percent of electric dryers, and 31
percent of refrigerators. Analysts believed that the combined firms would be required to divest certain
Maytag product lines to receive approval. Recognizing the potential difficulty in getting regulatory
approval, the Whirlpool/Maytag contract allowed Whirlpool (the acquirer) to withdraw from the contract
by paying a “reverse breakup” fee of $120 million to Maytag (the target). Breakup fees are normally paid
by targets to acquirers if they choose to withdraw from the contract.
U.S. regulators tended to view the market as global in nature. When the appliance market is defined in a
global sense, the combined firms’ share drops to about one fourth of the previously mentioned levels. The
number and diversity of foreign manufacturers offered a wide array of alternatives for consumers.
Moreover, there are few barriers to entry for these manufacturers wishing to do business in the United
States. Many of Whirlpool’s independent retail outlets wrote letters supporting the proposal to acquire
Maytag as a means of sustaining financially weakened companies. Regulators also viewed the preservation
of jobs as an important consideration in its favorable ruling.
Discussion Questions:
1. What is anti-trust policy and why is it important?
2. What factors other than market share should be considered in determining whether a potential
merger might result in an increased pricing power?
FCC Uses Its Power to Stimulate Competition in the Telecommunications Market
Oh, So Many Hurdles
Having received approval from the Justice Department and the Federal Trade Commission, Ameritech and
SBC Communications received permission from the Federal Communications Commission to combine to
form the nation’s largest local telephone company. The FCC gave its approval of the $74 billion
transaction, subject to conditions requiring that the companies open their markets to rivals and enter new
markets to compete with established local phone companies.
Satisfying the FCC’s Concerns
SBC, which operates under Southwestern Bell, Pacific Bell, SNET, Nevada Bell, and Cellular One
brands, has 52 million phone lines in its territory. It also has 8.3 million wireless customers across the
United States. Ameritech, which serves Illinois, Indiana, Michigan, Ohio, and Wisconsin, has more than 12
million phone customers. It also provides wireless service to 3.2 million individuals and businesses.
A Costly Remedy for SBC
SBC has had considerable difficulty in complying with its agreement with the FCC. Between December
2000 and July 2001, SBC paid the U.S. government $38.5 million for failing to provide adequately rivals
with access to its network. The government noted that SBC failed repeatedly to make available its network
in a timely manner, to meet installation deadlines, and to notify competitors when their orders were filled.
Discussion Questions:
1. Comment on the fairness and effectiveness of using the imposition of heavy fines to promote
social policy.
2. Under what circumstances, if any, do you believe the government should relax the imposition of
such fines in the SBC case?
Exxon and Mobil Merger—The Market Share Conundrum
Following a review of the proposed $81 billion merger in late 1998, the FTC decided to challenge the
Exxon–Mobil transaction on anticompetitive grounds. Options available to Exxon and Mobil were to
challenge the FTC’s rulings in court, negotiate a settlement, or withdraw the merger plans. Before the
merger, Exxon was the largest oil producer in the United States and Mobil was the next largest firm. The
combined companies would create the world’s biggest oil company in terms of revenues. Top executives
from Exxon Corporation and Mobil Corporation argued that they needed to implement their proposed
merger because of the increasingly competitive world oil market. Falling oil prices during much of the late
1990s put a squeeze on oil industry profits. Moreover, giant state–owned oil companies are posing a
competitive threat because of their access to huge amounts of capital. To offset these factors, Exxon and
Mobil argued that they had to combine to achieve substantial cost savings.
After a year-long review, antitrust officials at the FTC approved the Exxon–Mobil merger after the
companies agreed to the largest divestiture in the history of the FTC. The divestiture involved the sale of
15% of their service station network, amounting to 2400 stations. This included about 1220 Mobil stations
from Virginia to New Jersey and about 300 in Texas. In addition, about 520 Exxon stations from New York
to Maine and about 360 in California were divested. Exxon also agreed to the divestiture of an Exxon
refinery in Benecia, California. In entering into the consent decree, the FTC noted that there is
considerably greater competition worldwide. This is particularly true in the market for exploration of new
reserves. The greatest threat to competition seems to be in the refining and distribution of gasoline.
Discussion Questions:
1. How does the FTC define market share?
2. Why might it be important to distinguish between a global and a regional oil and gas market?
3. Why are the Exxon and Mobil executives emphasizing efficiencies as a justification for this
merger?
4. Should the size of the combined companies be an important consideration in the regulators’
analysis of the proposed merger?
5. How do the divestitures address perceived anti-competitive problems?
FTC Prevents Staples from Acquiring Office Depot
As the leading competitor in the office supplies superstore market, Staples’ proposed $3.3 billion
acquisition of Office Depot received close scrutiny from the FTC immediately after its announcement in
September 1996. The acquisition would create a huge company with annual sales of $10.7 billion.
Following the acquisition, only one competitor, OfficeMax with sales of $3.3 billion, would remain.
Staples pointed out that the combined companies would comprise only about 5% of the total office supply
market. However, the FTC considered the superstore market as a separate segment within the total office
supply market. Using the narrow definition of “market,” the FTC concluded that the combination of Staples
and Office Depot would control more than three-quarters of the market and would substantially increase the
pricing power of the combined firms. Despite Staples’ willingness to divest 63 stores to Office Max in
markets in which its concentration would be the greatest following the merger, the FTC could not be
persuaded to approve the merger.
Staples continued its insistence that there would be no harmful competitive effects from the proposed
merger, because office supply prices would continue their long–term decline. Both Staples and Office
Depot had a history of lowering prices for their customers because of the efficiencies associated with their
“superstores.” The companies argued that the merger would result in more than $4 billion in cost savings
over 5 years that would be passed on to their customers. However, the FTC argued and the federal court
concurred that the product prices offered by the combined firms still would be higher, as a result of reduced
competition, than they would have been had the merger not taken place. The FTC relied on a study
showing that Staples tended to charge higher prices in markets in which it did not have another superstore
as a competitor. In early 1997, Staples withdrew its offer for Office Depot.
Discussion Questions:
1. How important is properly defining the market segment in which the acquirer and target
companies compete to determining the potential increased market power if the two are
permitted to combine? Explain your answer.
2. Do you believe the FTC was being reasonable in not approving the merger even though?
Staples agreed to divest 63 stores in markets where market concentration would be the greatest
following the merger? Explain your answer.
Justice Department Blocks Microsoft’s Acquisition of Intuit
In 1994, Bill Gates saw dominance of the personal financial software market as a means of becoming a
central player in the global financial system. Critics argued that, by dominating the point of access (the
individual personal computer) to online banking, Microsoft believed that it may be possible to receive a
small share of the value of each of the billions of future personal banking transactions once online banking
became the norm. With a similar goal in mind, Intuit was trying to have its widely used financial software
package, Quicken, incorporated into the financial standards of the global banking system. In 1994, Intuit
had acquired the National Payment Clearinghouse Inc., an electronic bill payments system integrator, to
help the company develop a sophisticated payments system. By 1995, Intuit had sold more than 7 million
copies of Quicken and had about 300,000 bank customers using Quicken to pay bills electronically. In
contrast, efforts by Microsoft to penetrate the personal financial software market with its own product,
Money, were lagging badly. Intuit’s product, Quicken, had a commanding market share of 70% compared
to Microsoft’s 30%.
In 1994 Microsoft made a $1.5 billion offer for Intuit. Eventually, it would increase its offer to $2
billion. To appease its critics, it offered to sell its Money product to Novell Corporation. Almost
immediately, the Justice Department challenged the merger, citing its concern about the anticompetitive
effects on the personal financial software market. Specifically, the Justice Department argued that, if
consummated, the proposed transaction would add to the dominance of the number-one product Quicken,
weaken the number two-product (Money), and substantially increase concentration and reduce competition
in the personal finance/checkbook software market. Moreover, the DoJ argued that there would be few new
entrants because competition with the new Quicken would be even more difficult and expensive.
Microsoft and its supporters argued that government interference would cripple Microsoft’s ability to
innovate and limit its role in promoting standards that advance the whole software industry. Only a
Microsoft–Intuit merger could create the critical mass needed to advance home banking. Despite these
arguments, the regulators would not relent on their position. On May 20, 1995, Microsoft announced that it
was discontinuing efforts to acquire Intuit to avoid expensive court battle with the Justice Department.
Discussion Questions:
1. Explain how Microsoft’s acquisition of Intuit might limit the entry of new competitors into the
financial software market.
2. How might the proliferation of Internet usage in the twenty-first century change your answer
to question 1?
3. Do you believe that the FTC might approve of Microsoft acquiring Intuit today? Why or why
not?
How the Microsoft Case Could Define Antitrust Law in the “New Economy”
The Microsoft case was about more than just the software giant’s misbehavior. Antitrust law was also on
trial. When the Justice Department sued Microsoft in 1998, it argued that the century old Sherman Antitrust
Act could be applied to police high tech monopolies. This now looks doubtful. As the digital economy
evolves, it is likely to be full of natural monopolies (i.e., those in which only one producer can survive, in
hardware, software, and communications), since consumers are motivated to prefer products compatible
with ubiquitous standards. Under such circumstances, monopolies emerge. Companies whose products set
the standards will be able to bundle other products with their primary offering, just like Microsoft has done
with its operating system. What type of software can and cannot be bundled continues to be a thorny issue
for antitrust policy.
Although the proposed remedy did not stand on appeal, the Microsoft case had precedent value because
of the perceived importance of innovation in the information–based, technology–driven “new economy.”
This case illustrates how “trust busters” are increasingly viewing innovation as a central issue in
enforcement policy. Regulators increasingly are seeking to determine whether proposed business
combinations either promote or impede innovation.
Because of the accelerating pace of new technology, government is less likely to want to be involved in
imposing remedies that seek to limit anticompetitive behaviors by requiring the government to monitor
continuously a firm’s performance to a consent decree. In fact, the government’s frustration with the
ineffectiveness of sanctions imposed on Microsoft in the early 1990s may have been a contributing factor
in their proposal to divide the firm.
Antitrust watchdogs are likely to pay more attention in the future to the impact of proposed mergers or
acquisitions on start-ups, which are viewed as major contributors to innovation. In some instances, business
combinations among competitors may be disallowed if they are believed to be simply an effort to slow the
rate of innovation. The challenge for regulators will be to recognize when cooperation or mergers among
competitors may provide additional incentives for innovation through a sharing of risk and resources.
However, until the effects on innovation of a firm’s actions or a proposed merger can be more readily
measured, decisions by regulators may appear to be more arbitrary than well reasoned.
The economics of innovation are at best ill-defined. Innovation cycles are difficult to determine and may
run as long as several decades between the gestation of an idea and its actual implementation.
Consequently, if it is to foster innovation, antitrust policy will have to attempt to anticipate technologies,
markets, and competitors that do not currently exist to determine which proposed business combinations
should be allowed and which firms with substantial market positions should be broken up.
Discussion Questions:
1. Comment on whether antitrust policy can be used as an effective means of encouraging
innovation.
2. Was Microsoft a good antitrust case in which to test the effectiveness of antitrust policy on
promoting innovation? Why or why not?
Anthem-Well Point Merger Hits Regulatory Snag
In mid-2004, a California insurance regulator refused to approve Anthem Inc’s (“Anthem”) $20 billion
acquisition of WellPoint Health NetWorks Incorporated (“WellPoint”). If allowed, the proposed merger
would result in the nation’s largest health insurer, with 28 million members. After months of regulatory
review, the deal had already received approval from 10 state regulators, the Justice Department, and 97% of
the shares outstanding of both firms. Nonetheless, California Insurance Commissioner, John Garamendi,
denounced the proposed transaction as unreasonably enriching the corporate officers of the firms without
improving the availability or quality of healthcare. Earlier the same day, Lucinda Ehnes, Director of the
Department of Managed Healthcare in California approved the transaction. The Managed Healthcare
Agency has regulatory authority over Blue Cross of California, a managed healthcare company that is by
far the largest and most important WellPoint operation in the state. Mr. Garamendi’s department has
regulatory authority over about 4% of WellPoint’s California business through its BC Life & Health
Insurance Company subsidiary (“BC”). Interestingly, Ms. Ehnes is an appointee of California’s Republican
governor, Arnold Schwarzenegger, while Mr. Garamendi, a Democrat, is an elected official who had
previously run unsuccessfully for governor. Moreover, two week’s earlier he announced that he will be a
candidate for lieutenant governor in 2006.
Mr. Garamendi had asked Anthem to invest in California’s low income communities an amount equal to
the executive compensation payable to WellPoint executives due to termination clauses in their contracts.
Estimates of the executive compensation ranged as high as $600 million. Anthem immediately sued John
Garamendi, seeking to overrule his opposition to the transaction. In the lawsuit, Anthem argued that
Garamendi acted outside the scope of his authority by basing his decision on personal beliefs about
healthcare policy and executive compensation rather than on the criteria set forth in California state law.
Anthem argued that the executive compensation payable for termination if WellPoint changed ownership
was part of the affected executives’ employment contracts negotiated well in advance of the onset of
Anthem’s negotiations to acquire WellPoint. The California insurance regulator finally dropped his
objections when the companies agreed to pay $600 million to help cover the cost of treating California’s
uninsured residents.
Following similar concessions in Georgia, Anthem was finally able to complete the transaction on
December 1, 2004. Closing occurred almost one year after the transaction had been announced.
Discussion Questions:
1. If you were the Anthem CEO, would you withdraw from the deal, initiate a court battle, drop the
Blue Cross subsidiary from the transaction, agree to regulators’ demands, or adopt some other
course of action? Explain your answer.
2. What are the risks to Anthem and WellPoint of delaying the closing date? Be specific.
3. To what extent should regulators use their powers to promote social policy?
The Bear Stearns Saga—When Failure Is Not an Option
Prodded by the Fed and the U.S. Treasury Department, J.P. Morgan Chase (JPM), the nation’s third largest
bank, announced, on March 17, 2008, that it had reached an agreement to buy 100 percent of Bear Stearns’s
outstanding equity for $2 per share. As one of the nation’s larger investment banks, Bear Stearns had a
reputation for being aggressive in the financial derivatives markets. Hammered out in two days, the
agreement called for the Fed to guarantee up to $30 billion of Bear Stearns’s “less liquid” assets. In an
effort to avoid what was characterized as a “systemic meltdown,” regulatory approval was obtained at a
breakneck pace. The Office of the Comptroller of Currency and Fed approvals were in place at the time of
the announcement. The SEC elected not to review the deal. Federal and state antitrust regulatory approvals
were obtained in record time.
With investors fleeing mortgage-backed securities, the Fed was hoping to prevent any further
deterioration in the value of such investments. The fear was that the financial crisis that beset Bear Stearns
could spread to other companies and ultimately test the Fed’s resources after it had said publicly that it
would lend up to $200 billion to banks in exchange for their holdings of mortgages.
Interestingly, Bear Stearns was not that big among investment banks when measured by asset size.
However, it was theoretically liable for as much as $10 trillion due to its holdings of such financial
derivatives as credit default swaps, in which it agreed to pay lenders in the event of a borrower defaulting.
If credit defaults became widespread, Bear Stearns would not have been able to honor its contractual
commitments, and the ability of other investment banks in similar positions would have been questioned
and the panic could have spread.
With Bear Stearns’s shareholders threatening not to approve what they viewed as a “fire sale,” JPM
provided an alternative bid, within several days of the initial bid, in which it offered $2.4 billion for about
40 percent of the stock, or about $10 per share. In exchange for the higher offer, Bear Stearns agreed to sell
95 million newly issued shares to JPM, giving JPM a 39.5 percent stake and an almost certain majority in
any shareholder vote, effectively discouraging any alternative bids. Under the new offer, JPM assumed
responsibility for the first $1 billion in asset losses, before the Fed’s guarantee of up to $30 billion takes
effect..
Discussion Questions:
1 Why do you believe government regulators encouraged a private firm (J.P. Morgan Chase) to acquire
Bear Stearns rather than have the government take control? Do you believe this was the appropriate
course of action? Explain your answer.
2 By facilitating the merger, the Fed sent a message to Wall Street that certain financial institutions are
“too big to fail.” What effect do you think the merger will have on the future investment activities of
investment banks? Be specific.