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renegotiated aircraft and other leases and earned $220 million in the second quarter of 2013 while in
Chapter 11, its first profit in that quarter in 6 years. It was proposing to lease hundreds of new planes upon
exiting bankruptcy.
On December 9, 2013, American and US Airways announced the completion of their merger to form
American Airlines Group. Challenges remain. The task of creating the world’s largest airline requires
combining two carriers with vastly different operating cultures and backgrounds, as well as their own
strained labor histories. It can take up to 2 years for airlines to merge fleets, repaint planes, plan new routes,
and to seamlessly tie together complex computer systems. United learned the hard way in 2012 when its
reservation system failed repeatedly, stranding travelers and forcing large-scale cancellations.
The outlook for labor peace is promising with a lot of trust existing between American’s management
and labor union leadership representing its three major employee groups: pilots, flight attendants, and
ground workers. Employees also have a major portion of the new firm’s outstanding common shares. While
the bulk of management will come from US Airways, the technology will all come from American. Parker
has extensive experience in the challenges of integrating airlines. In 2005, when American West acquired
US Airways the pilots from each of these firms have yet to agree on a common contract and seniority rules
and to this day cannot fly together.
As a result of this merger, US airline industry capacity measured by the number of seats per mile flown
is expected to drop by about 4% during the next several years as redundant or underperforming routes are
pruned. While the agreements with the Justice Department and Department of Transportation require the
new airline to maintain all hubs and expand service to some new cities, history shows merging airlines tend
to make fewer flights in the years following the merger. After all, the driving force behind consolidation is
the elimination of redundant capacity. One area of growth for American may be on Pacific routes, where
capacity could increase as much as 20% in the coming years. Almost all capacity reductions in American
and US Airways will be on domestic routes where there is more competition from Southwest and smaller
carriers such as JetBlue Airways Corp and Virgin American Inc. Indeed, regulatory approval of the
American and US Airways merger appears to have shaped the competitive landscape in the airline industry
for years to come.
Discussion Questions
1. Whose interests do you believe antitrust regulators represent? What trade-offs do antitrust
regulators face in making decisions that impact the groups whose interests they represent? Be
specific.
2. Speculate as to why the share prices of American and US Airways increased sharply on the day
that the agreement with the Justice Department had been reached? Why did the share prices of
other major airlines also increase?
3. Why do you believe the regulators approved the deal despite the large increase in industry
concentration and their awareness that historically increases in concentration would likely result
in a further reduction in industry capacity?
4. How does the approval of a merger involving a firm in Chapter 11 complicate decision making for
regulators?
5. How did the delay in filing the Justice Department lawsuit impact the economic viability of
American Airlines?
Regulatory Challenges in Cross-Border Mergers
______________________________________________________________________________________
Key Points
Such mergers entail substantially greater regulatory challenges than domestic M&As.
Realizing potential synergies may be limited by failure to receive support from regulatory agencies in
the countries in which the acquirer and target firms have operations.
______________________________________________________________________________________
European Commission antitrust regulators formally blocked the attempted merger between the NYSE
Group and Deutsche Borse on February 4, 2012, nearly one year after the exchanges first announced the
deal. The stumbling block appeared to be the inability of the parties involved to reach agreement on
divesting their derivatives trading markets. The European regulators argued that the proposed merger
would result in the combined exchanges obtaining excessive pricing power without the sale of the
derivatives trading markets. The disagreement focused on whether the exchange was viewed as primarily a
European market or a global market.
The NYSE Group is the world’s largest stock and derivatives exchange, as measured by market
capitalization. A product of the combination of the New York Stock Exchange and Euronext NV (the
European exchange operator), the NYSE Group reversed the three-year slide in both its U.S. and European
market share in 2011. The slight improvement in market share was due more to an increase in technology
spending than any change in the regulatory environment. The key to unlocking the full potential of the
international exchange remained the willingness of countries to harmonize the international regulatory
environment for trading stocks and derivatives.
Valued at $11 billion, the mid-2007 merger created the first transatlantic stock and derivatives market.
Organizationally, the NYSE Group operates as a holding company, with its U.S. and European operations
run largely independently. The combined firms trade stocks and derivatives through the New York Stock
Exchange, on the electronic Euronext Liffe Exchange in London, and on the stock exchanges in Paris,
Lisbon, Brussels, and Amsterdam.
In recent years, most of the world’s major exchanges have gone public and pursued acquisitions. Before
this 2007 deal, the NYSE merged with electronic trading firm Archipelago Holdings, while NASDAQ
Stock Market Inc. acquired the electronic trading unit of rival Instinet. This consolidation is being driven
by declining trading fees, improving trading information technology, and relaxed cross-border restrictions
on capital flows and in part by increased regulation in the United States. U.S. regulation, driven by
Sarbanes-Oxley, contributed to the transfer of new listings (IPOs) overseas. The strategy chosen by U.S.
exchanges for recapturing lost business is to follow these new listings overseas.
Larger companies that operate across multiple continents also promise to attract more investors to
trading in specific stocks and derivatives contracts, which could lead to cheaper, faster, and easier trading.
As exchange operators become larger, they can more easily cut operating and processing costs by
eliminating redundant or overlapping staff and facilities and, in theory, pass the savings along to investors.
Moreover, by attracting more buyers and sellers, the gap between prices at which investors are willing to
buy and sell any given stock (i.e., the bid and ask prices) should narrow. The presence of more traders
means more people are bidding to buy and sell any given stock. This results in prices that more accurately
reflect the true underlying value of the security because of more competition. The cross-border mergers
also should make it easier and cheaper for individual investors to buy and sell foreign shares.
Before these benefits can be fully realized, numerous regulatory hurdles have to be overcome. Even if
exchanges merge, they must still abide by local government rules when trading in the shares of a particular
company, depending on where the company is listed. Companies are not eager to list on multiple exchanges
worldwide because that subjects them to many countries’ securities regulations and a bookkeeping
nightmare. At the local level, little has changed in how markets are regulated. European companies list their
shares on exchanges owned by the NYSE Group. These exchanges still are overseen by individual national
regulators. In the United States, the SEC still oversees the NYSE but does not have a direct say over
Europe, except in that it would oversee the parent company, the NYSE Group, since it is headquartered in
New York. EU member states continue to set their own rules for clearing and settlement of trades. If the
NYSE and Euronext are to achieve a more unified and seamless trading system, regulators must reach
agreement on a common set of rules. Achieving this goal seems to remain well in the future. Consequently,
it may be years before the anticipated synergies are realized.
Discussion Questions:
1. What are the key challenges facing regulators resulting from the merger of financial
exchanges in different countries? How do you see these challenges being resolved?
2. In what way are these regulatory issues similar or different from those confronting the SEC and
state regulators and the European Union and individual country regulators?
3. Who should or could regulate global financial markets?
4. In your opinion, will the merging of financial exchanges increase or decrease international
financial stability?
The Importance of Timing: The Express Scripts and Medco Merger
______________________________________________________________________________________
Key Points
• While important, industry concentration is only one of many factors antitrust regulators use in
investigating proposed M&As.
• The timing of the proposed Express Scripts–Medco merger could have been the determining factor
in its receiving regulatory approval.
______________________________________________________________________________________
Following their rejection of two of the largest M&As announced in 2011 over concern about increased
industry concentration, U.S. antitrust regulators approved on April 2, 2012, the proposed takeover of
pharmacy benefits manager Medco Health Solutions Inc. (Medco) by Express Scripts Inc., despite similar
misgivings by critics. Pharmacy benefit managers (PBMs) are third-party administrators of prescription
drug programs responsible for processing and paying prescription drug claims. More than 210 million
Americans receive drug benefits through PBMs. Their customers include participants in plans offered by
Fortune 500 employers, Medicare Part D participants, and the Federal Employees Health Benefits Program.
The $29.1 billion Express Scripts–Medco merger created the nation’s largest pharmacy benefits
manager administering drug coverage for employers and insurers through its mail order operations, which
could exert substantial influence on both how and where patients buy their prescription drugs. The
combined firms will be called Express Scripts Holding Company and will have $91 billion in annual
revenue and $2.5 billion in after-tax profits. Including debt, the deal is valued at $34.3 billion. Together the
two firms controlled 34% of the prescription drug market in the first quarter of 2012, processing more than
1.4 billion prescriptions; CVS-Caremark is the next largest, with 17% market share. The combined firms
also will represent the nation’s third-largest pharmacy operator, trailing only CVS Caremark and Walgreen
Co.
The Federal Trade Commission’s approval followed an intensive eight-month investigation and did not
include any of the customary structural or behavioral remedies that accompany approval of mergers
resulting in substantial increases in industry concentration. FTC antitrust regulators voting for approval
argued that the Express Scripts–Medco deal did not present significant anticompetitive concerns, since the
PBM market is more susceptible to new entrants and current competitors provide customers significant
alternatives. Furthermore, the FTC concluded that Express Scripts and Medco did not represent particularly
close competitors and that the merged firms would not result in monopolistic pricing power. In addition,
approval may have reflected the belief that the merged firms could help reduce escalating U.S. medical
costs because of their greater leverage in negotiating drug prices with manufacturers and their ability to cut
operating expenses by eliminating overlapping mail-handling operations. The FTC investigation also found
that most of the large private health insurance plans offer PBM services, as do other private operators. Big
private employers are the major customers of PBMs and have proven to be willing to switch PBMs if
another has a better offer. For example, Medco lost one-third of its business during 2011, primarily to CVS
Caremark.
In addition, to CVS Caremark Corp, PBM competitors include UnitedHealth, which has emerged as a
recent entrant into the business. Having been one of Medco’s largest customers, UnitedHealth did not
renew its contract, which expired in 2012, with Medco, which covered more than 20 million of its
pharmacy benefit customers. Other competitors include Humana, Aetna, and Cigna, all of which have their
own PBM services competing for managing drug benefits covered under Medicare Part D. With the loss of
UnitedHealth’s business, Express Script–Medco’s share dropped from 34% in early 2012 to 29% at the end
of that year.
Critics of the proposed merger argued that smaller PBM firms often do not have the bargaining power
and data-handling capabilities of their larger competitors. Moreover, benefit managers can steer health plan
participants to their own pharmacy-fulfillment services, and employers have little choice but to agree, due
to their limited leverage. Opponents argue that the combination will reduce competition, ultimately raising
drug prices. As the combined firms push for greater use of mail-ordering prescriptions instead of local
pharmacies, smaller pharmacies could be driven out of business, for mail-order delivery is far cheaper for
both PBMs and patients than dispensing drugs at a store.
Discussion Questions:
1. Why do you believe the U.S. antitrust regulators approved the merger despite the large increase in
industry concentration?
2. Did the timing of the proposed merger between Express Scripts and Medco help or hurt the firms
in obtain regulatory approval? Be specific.
3. Speculate as to how the Express Scripts-Medco merger might influence the decisions of their
competitors to merge? Be specific.
Gaining Regulatory Approval Often Requires Concessions By Merger Partners
Key Points:
• Regulators often consider market concentration when determining whether an M&A will drive up
prices and reduce consumer choice and product/service quality.
• To gain regulatory approval, acquirers often are compelled to sell assets to another firm to either
strengthen that firm’s competitive position or to create another viable competitor.
What may seem to make good business sense on paper often takes years to complete. First, Anheuser-
Busch InBev (ABI) had to reach an agreement with the highly reluctant takeover target, Grupo Modelo
(Modelo). Second, ABI had to convince regulators that the deal would not reduce competition in the US
beer market. Consequently, this deal from start to finish took almost 5 years.
ABI, which already owned a 50% noncontrolling interest in Modelo, was interested in acquiring the
shares it did not own. These shares were mostly held by wealthy Mexican families. ABI is itself the result
of a $52 billion merger in 2008 between the maker of Anheuser-Busch and a Belgian-Brazilian brewer
InBev. It was looking to expand internationally and wanted to secure the rights to sell Corona’s and
Modelo’s other Mexican brands around the world, particularly in Europe and South America. Furthermore,
ABI believed that it could generate annual cost savings of as much as 1 billion dollars but only if it could
gain management control of the combined firms.
It took almost 2 years for ABI to resolve its differences with Modelo that started with ABI’s takeover of
Anheuser-Busch in 2008. Modelo claimed that Anheuser-Busch breached a prior agreement between the
two firms by failing to consult with the Mexican company on its sale to InBev. In 2010, an arbitration panel
ruled in favor of ABI, ending the dispute, and paving the way for ABI to buy the shares of Modelo it did
not own.
ABI and Modelo were able to reach an agreement on June 12, 2012, in which ABI would acquire the
Modelo outstanding shares at $9.15 per share in an all-cash deal valued at $20.1 billion. The purchase price
represented a 30% premium to Modelo’s closing price immediately before the announcement date. The size
of the premium raised investors’ ire as ABI’s shares sold off, but it may have been necessary to eliminate
any remaining Modelo shareholder resentment of ABI.
The US Justice Department sued to block the deal in January 2013 on the grounds that the deal as
structured would reduce competition in the US beer market. The deal would give ABI, the largest brewer in
the United States which controlled 39% market share prior to the merger, 46% of the US beer market. That
would essentially make the US beer market a duopoly with MillerCoors, the second largest US brewer,
controlling 26% of the market. The next largest company is Heineken USA with a 6% share.
The agreement gives Constellation, one of the US’s largest wine producers, full and permanent rights to
make and sell Corona, Corona Light, Modelo Especial, Pacifico and six other brands in the United States.
Constellation paid $5.5 billion for Modelo’s share of Crown Imports and for the Piedras Negras brewery.
Constellation has never brewed beer before making the deal a new direction for the firm. It currently
produces and distributes wine and spirits, including Robert Mondavi and Clos du Bois and Svedka vodka.
AT&T/T-MOBILE DEAL
SHORT-CIRCUITED BY REGULATORS
______________________________________________________________________________________
Key Points
Regulators often consider market concentration when determining whether an M&A will drive up
prices and reduce consumer choice and product/service quality.
What is an acceptable level of concentration often is difficult to determine.
Concentration may be an outgrowth of the high capital requirements of the industry.
Attempts to limit concentration may actually work to the detriment of some consumers.
______________________________________________________________________________________
United States antitrust regulators have moved aggressively in recent years to block horizontal mergers (i.e.,
those involving direct or potential competitors) while being more lenient on vertical deals (i.e., those in
which a firm buys a supplier or distributor). These actions foreshadowed the likely outcome of the deal
proposed by telecommunications giant AT&T to acquire T-Mobile for $39 billion in cash in early 2011.
Despite the unfavorable regulatory environment for horizontal deals, AT&T expressed confidence that it
could get approval for the deal when it accepted a sizeable termination fee as part of the agreement if it did
not complete the transaction by March 2012. However, the deal would never be completed, as U.S. antitrust
regulators made it clear that a tie-up between number two, AT&T (behind Verizon), and number four, T-
Mobile (behind Sprint), would not be permitted.
On December 20, 2011, AT&T announced that it would cease its nine-month fight to acquire T-Mobile.
AT&T was forced to pay T-Mobile’s parent, Deutsche Telekom, $3 billion in cash and a portion of its
wireless spectrum (i.e., cellular airwaves) valued at as much as $1 billion. T-Mobile and AT&T did agree
to enter into a seven-year roaming agreement1 that could cost AT&T another $1 billion. The announcement
came shortly after AT&T had ceased efforts to fight the Justice Department’s lawsuit filed in August 2011
to block the merger. The Justice Department would not accept any combination of divestitures or other
changes to the deal, arguing that the merger would raise prices to consumers and reduce both choice and
service quality. Instead, the Justice Department opted to keep a “strong” fourth competitor rather than allow
increased industry concentration.
But T-Mobile’s long-term viability was in doubt. The firm’s parent, Deutsche Telekom, had made it
clear that it wants to exit the mature U.S. market and that it has no intention of investing in a new high-
speed network. T-Mobile is the only national carrier that does not currently have its own next-generation
high-speed network. Because it is smaller and weaker than the other carriers, it does not have the cash or
the marketing clout with handset vendors to offer exclusive, high-end smartphones to attract new
customers. While competitors Verizon and AT&T gained new customers, T-Mobile lost 90,000 customers
during 2011.
In response to these developments, T-Mobile announced a merger with its smaller rival MetroPCS on
October 3, 2012, creating the potential for a stronger competitor to Verizon and AT&T and solving
regulators’ concerns about increased concentration. However, it creates another issue by reducing
competition in the prepaid cell phone segment. MetroPCS’s low-cost, no-contract data plans and cheaper
phones brought cellphones and mobile Internet to millions of Americans who could not afford major-
carrier contracts. While T-Mobile announced the continuation of prepaid service, it has an incentive not to
make it so attractive as to cause its own more profitable contract customers to shift to the prepaid service as
their contracts expire. While T-Mobile also announced plans to develop a new high-speed network, it will
be late to the game.
Some industries are more prone to increasing concentration because of their high capital needs. Only the
largest and most financially viable can support the capital outlays required to support national telecom
networks. While the U.S. Justice Department has sent a clear signal that mergers in highly concentrated
industries are likely to be disallowed, it is probable that the U.S. cellular industry will become increasingly
concentrated despite disallowing the AT&T/T-Mobile merger due to the highly capital-intensive nature of
the business.
Justice Department Requires VeriFone Systems to Sell Assets
before Approving Hypercom Acquisition
Key Points:
• Asset sales commonly are used by regulators to thwart the potential build-up of market power
resulting from a merger or acquisition.
• In such situations, defining the appropriate market served by the merged firms is crucial to
identifying current and potential competitors.
______________________________________________________________________________
In late 2011, VeriFone Systems (VeriFone) reached a settlement with the U.S. Justice Department to
acquire competitor Hypercom Corp on the condition it sold Hypercom’s U.S. point-of-sale terminal
business. Business use point-of-sale terminals are used by retailers to accept electronic payments such as
credit and debit cards.
1 Roaming agreements are arrangements between wireless companies to provide wireless service to each
other’s subscribers in areas where a carrier’s coverage is spotty.
The Justice Department had sued to block the $485 million deal on concerns that the combination would
limit competition in the market for retail checkout terminals. The asset sale is intended to create a
significant independent competitor in the U.S. The agreement stipulates that private equity firm Gores
Group LLC will buy the terminals business.
San Jose, California-based VeriFone is the second largest maker of electronic payment equipment in the
U.S. and Hypercom, based in Scottsdale, Arizona, is number three. Together, the firms control more than
60 percent of the U.S. market for terminals used by retailers. Ingenico SA, based in France, is the largest
maker of card-payment terminals. The Justice Department had blocked a previous attempt to sell
Hypercom’s U.S. point-of-sale business to rival Ingenico, saying that it would have increased concentration
and undermined competition.
VeriFone will retain Hypercom’s point-of-sale equipment business outside the U.S. The acquisition will
enable VeriFone to expand in the emerging market for payments made via mobile phones by giving it a
larger international presence in retail stores and the opportunity to install more terminals capable of
accepting mobile phone payments abroad.
Discussion Questions
1. Do you believe requiring consent decrees that oblige the acquiring firm to dispose of certain target
company assets is an abuse of government power? Why or why not?
2. What alternative actions could the government take to limit market power resulting from a business
combination?
The Legacy of GE's Aborted Attempt to Merge with Honeywell
Many observers anticipated significant regulatory review because of the size of the transaction and the
increase in concentration it would create in the markets served by the two firms. Most believed, however,
that, after making some concessions to regulatory authorities, the transaction would be approved, due to its
perceived benefits. Although the pundits were indeed correct in noting that it would receive close scrutiny,
they were completely caught off guard by divergent approaches taken by the U.S. and EU antitrust
authorities. U.S regulators ruled that the merger should be approved because of its potential benefits to
customers. In marked contrast, EU regulators ruled against the transaction based on its perceived negative
impact on competitors.
Honeywell's avionics and engines unit would add significant strength to GE's jet engine business. The
deal would add about 10 cents to GE's 2001 earnings and could eventually result in $1.5 billion in annual
cost savings. The purchase also would enable GE to continue its shift away from manufacturing and into
services, which already constituted 70 percent of its revenues in 2000.2 The best fit is clearly in the
combination of the two firms' aerospace businesses. Revenues from these two businesses alone would total
$22 billion, combining Honeywell's strength in jet engines and cockpit avionics with GE's substantial
business in larger jet engines. As the largest supplier in the aerospace industry, GE could offer airplane
2 BusinessWeek, 2000b
manufacturers "one-stop shopping" for everything from engines to complex software systems by cross-
selling each other's products to their biggest customers.
Honeywell had been on the block for a number of months before the deal was consummated with GE.
Its merger with Allied Signal had not been going well and contributed to deteriorating earnings and a much
lower stock price. Honeywell's shares had declined in price by more than 40 percent since its acquisition of
Allied Signal. While the euphoria surrounding the deal in late 2000 lingered into the early months of 2001,
rumblings from the European regulators began to create an uneasy feeling among GE's and Honeywell's
management.
Mario Monti, the European competition commissioner at that time, expressed concern about possible
"conglomerate effects" or the total influence a combined GE and Honeywell would wield in the aircraft
industry. He was referring to GE's perceived ability to expand its influence in the aerospace industry
through service initiatives. GE's services offerings help differentiate it from others at a time when the prices
of many industrial parts are under pressure from increased competition, including low-cost manufacturers
overseas. In a world in which manufactured products are becoming increasingly commodity-like, the true
winners are those able to differentiate their product offering. GE and Honeywell's European competitors
complained to the EU regulatory commission that GE's extensive services offering would give it entrée into
many more points of contact among airplane manufacturers, from communications systems to the expanded
line of spare parts GE would be able to supply. This so-called range effect or portfolio power is a relatively
new legal doctrine that has not been tested in transactions of this size.3
On May 3, 2001, the U.S. Department of Justice approved the buyout after the companies agreed to sell
Honeywell's helicopter engine unit and take other steps to protect competition. The U.S. regulatory
authorities believed that the combined companies could sell more products to more customers and therefore
could realize improved efficiencies, although it would not hold a dominant market share in any particular
market. Thus, customers would benefit from GE's greater range of products and possibly lower prices, but
they still could shop elsewhere if they chose. The U.S. regulators expressed little concern that bundling of
products and services could hurt customers, since buyers can choose from among a relative handful of
viable suppliers.
The EU authorities continued to balk at approving the transaction without major concessions from the
participants—concessions that GE believed would render the deal unattractive. On June 15, 2001, GE
submitted its final offer to the EU regulators in a last-ditch attempt to breathe life into the moribund deal.
GE knew that if it walked away, it could continue as it had before the deal was struck, secure in the
knowledge that its current portfolio of businesses offered substantial revenue growth or profit potential.
Honeywell clearly would fuel such growth, but it made sense to GE's management and shareholders only if
it would be allowed to realize potential synergies between the GE and Honeywell businesses.
GE said it was willing to divest Honeywell units with annual revenue of $2.2 billion, including regional
jet engines, air-turbine starters, and other aerospace products. Anything more would jeopardize the
rationale for the deal. Specifically, GE was unwilling to agree not to bundle (i.e., sell a package of
components and services at a single price) its products and services when selling to customers. Another
stumbling block was the GE Capital Aviation Services unit, the airplane-financing arm of GE Capital. The
EU Competition Commission argued that that this unit would use its influence as one of the world's largest
purchasers of airplanes to pressure airplane manufacturers into using GE products. The commission seemed
3 Murray, 2001
to ignore that GE had only an 8 percent share of the global airplane leasing market and would therefore
seemingly lack the market power the commission believed it could exert.
On July 4, 2001, the European Union vetoed the GE purchase of Honeywell, marking it the first time a
proposed merger between two U.S. companies has been blocked solely by European regulators. Having
received U.S. regulatory approval, GE could ignore the EU decision and proceed with the merger as long as
it would be willing to forego sales in Europe. GE decided not to appeal the decision to the EU Court of
First Instance (the second highest court in the European Union), knowing that it could take years to resolve
the decision, and withdrew its offer to merge with Honeywell.
In the wake of these court rulings and in an effort to avoid similar situations in other geographic regions,
coordination among antitrust regulatory authorities in different countries has improved. For example, in
mid-2010, the U.S. Federal Trade Commission reached a consent decree with scientific instrument
manufacturer Agilent in approving its acquisition of Varian, in which Agilent agreed to divest certain
overlapping product lines. While both firms were based in California, each has extensive foreign
operations, which necessitated gaining the approval of multiple regulators. Throughout the investigation,
FTC staff coordinated enforcement efforts with the staffs of regulators in the European Union, Australia,
and Japan. The cooperation was conducted under the auspices of certain bilateral cooperation agreements,
the OECD Recommendation on Cooperation among its members, and the European Union Best Practices
on Cooperation in Merger Investigation protocol.
Discussion Questions
1. What are the important philosophical differences between U.S. and EU antitrust regulators?
Explain the logic underlying these differences? To what extent are these differences influenced by
political rather than economic considerations? Explain your answer.
2. This is the first time that a foreign regulatory body has prevented a deal involving U.S. firms only
from occurring. What do you think are the long-term implications, if any, of this precedent?
3. What were the major obstacles between GE and the EU regulators? Why do you think these were
obstacles? Do you think the EU regulators were justified in their position? Why/why not?
4. Do you think that competitors are using antitrust to their advantage? Explain your answer.
5. Do you think the EU regulators would have taken a different position if the deal had involved a
less visible firm than General Electric? Explain your answer.
The Lehman Brothers Meltdown
Even though regulations are needed to promote appropriate business practices, they may also produce a
false sense of security. Regulatory agencies often are coopted by those they are supposed to be regulating
due to an inherent conflict of interest. The objectivity of regulators can be skewed by the prospect of future
employment in the firms they are responsible for policing. No matter how extensive, regulations are likely
to fail to achieve their intended purpose in the absence of effective regulators.
Consider the 2008 credit crisis that shook Wall Street to its core. On September 15, 2008, Lehman
Brothers Holdings announced that it had filed for bankruptcy. Lehman's board of directors decided to opt
for court protection after attempts to find a buyer for the entire firm collapsed. With assets of $639 billion
and liabilities of $613 billion, Lehman is the largest bankruptcy in history in terms of assets. The next
biggest bankruptcies were WorldCom and Enron, with $126 billion and $81 billion in assets, respectively.
In the months leading up to Lehman’s demise, there were widespread suspicions that the book value of
the firm’s assets far exceeded their true market value and that a revaluation of these assets was needed.
However, little was known about Lehman’s aggressive use of repurchase agreements or repos. Repos are
widely used short-term financing contracts in which one party agrees to sell securities to another party (a
so-called counterparty), with the obligation to buy them back, often the next day. Because the transactions
are so short-term in nature, the securities serving as collateral continue to be shown on the borrower’s
balance sheet. The cash received as a result of the repo would increase the borrower’s cash balances and be
offset by a liability reflecting the obligation to repay the loan. Consequently, the borrower’s balance sheet
would not change as a result of the short-term loan.
In early 2010, a report compiled by bank examiners indicated how Lehman manipulated its financial
statements, with government regulators, the investing public, credit rating agencies, and Lehman’s board of
directors being totally unaware of the accounting tricks. Lehman departed from common accounting
practices by booking these repos as sales of securities rather than as short-term loans. By treating the repos
as a sale of securities (rather than a loan), the securities serving as collateral for the repo were removed
from the books, and the proceeds generated by the repo were booked as if they had been used to pay off an
equivalent amount of liabilities. The resulting reduction in liabilities gave the appearance that the firm was
less levered than it actually was despite the firm’s continuing obligation to buy back the securities. Since
