AAI column on Surface Transportation Board's Proposed Merger Guidelines, by Advisory Board members John Kwoka and Lawrence White

Dec 06 2000

The AAI sent a letter to the Surface Transportation Board criticizing its proposed railroad merger guidelines. The following column, by the authors of the letter, provides a summary.


Railroad Merger Rules Should Be Analytical, Objective, Transparent; So Far, They're Not

John E. Kwoka, Jr.Lawrence J. White

On October 3, 2000 the Surface Transportation Board issued proposed new rules for reviewing major rail consolidations. Based on comments filed in response to its earlier advance notice of rule-making, the Board described its existing procedures as "pro-merger" and conceded that they were inadequate for the kinds of competition issues and transitional problems raised by several recent large mergers, perhaps most notably Union Pacific-Southern Pacific. The proposed rules would (in the words of the Board) "upgrade the importance of competition" by requiring merging railroads to address a series of new considerations in their applications before the Board.

On behalf of the American Antitrust Institute, we submitted a letter to Board Chairman Linda Morgan, indicating our disagreement with the proposed procedures. The following is an excerpt and summary of that letter.

Merger policy and procedures as applied to the economy as a whole reflect two important principles that, in our view, are not adequately reflected in the Surface Transportation Board's proposed procedures.

First, the methodology employed in evaluating mergers should be, to the maximum degree possible, analytical, objective, and transparent. "Analytical" implies that the methodology has a solid foundation in well-developed theory that is supported by strong empirical evidence; objectivity implies a reliance upon clearly articulated rules; and transparency ensures that the process is comprehensible to outside observers and to prospective merging firms as well.

Second, the review process must reflect the fundamentally different incentives of merging companies compared to the reviewing agency. While the agency is charged with preserving competition and protecting the public interest, companies are expected to be motivated to maximize profits for the benefit of their shareholder/owners. The merger review process may therefore be partly cooperative, as firms supply information and engage in discussion of issues, but it is also partly adversarial. The agency expects firms to act in a self-interested manner and views their responses in that light.

From these premises have followed the well-established merger policy and procedures of the Federal Trade Commission and the Justice Department. As articulated in the Merger Guidelines and implemented by the agencies, this policy has been firmly grounded in economics and the law and explicit in its content. As a result, federal merger policy has gained much credibility and has served the overall U.S. economy very well.

The approach proposed in the Board's rule-making, however, does not embody these premises. While speaking more about competition, these procedures fail to articulate a clear policy and methodology and therefore, in our view, will not result in effective policy with respect to remaining major railroad consolidations.

Instead of being analytical, objective, and transparent, the core of the Board's proposed procedures is simply a set of broad principles, with the real methodology largely unexplained. They contain nothing analogous to the Merger Guidelines. There is no discussion of the definition of markets, no discussion of seller concentration, no discussion of ease or difficulty of entry, no discussion of buyer's power ­ nothing, in short, that discloses the Board's analytical methodology with respect to upcoming mergers.

As a result, it is impossible to determine what factors, and with what relative importance, will weigh in the Board's decisions with respect to prospective mergers. Neither railroads contemplating a merger nor shippers concerned about its consequences can anticipate how the Board will rule ­ at least not based on these stated procedures. Without a more explicit and comprehensive framework, this proposal cannot achieve the credibility and usefulness of the FTC-DOJ Merger Guidelines.

In addition, the proposal relies on the merging parties to offer information and remedies that are against their own interest. Under these rules, railroads would have an affirmative obligation to offer provisions that enhance competition, remedy possible competitive problems, deal with various adverse contingencies, and even anticipate the interaction effects of its merger with other possible mergers. While some of these topics are inevitable and appropriate subjects of discussion between a reviewing agency and the parties, this formulation goes well beyond that and seeks actually to enlist the merger applicants into the process of analysis and remedy. Perhaps most strikingly, the parties are supposed to offer up methods by which competition will actually be strengthened by their merger, despite the fact that strengthening competition is not in their interests and so any proposals to that effect ought to be viewed with great skepticism.

Merging railroads may have been partners with the Board during the past twenty years of explicitly pro-merger policy, but a truly objective analysis of future mergers cannot be conducted in the same manner. Applicants must be expected to be advocates of the merger, not its critics or planners for its possible failure. Whatever the parties may provide in response to these new obligations ought therefore to be seen as self-serving, rather than furthering the competition mission of the Board. Anticipating otherwise is a prescription for ineffective policy at best, and more likely, a fundamentally misguided one.

Accordingly, we urge the Board to reformulate its proposed statement and regulations. We urge that its approach be more analytical, objective, and transparent in its approach. We also recommend that it reflect a recognition that the parties' incentives are ultimately incompatible with the purposes of the agency. Only by making these changes will the Board's oversight result in decisions that truly serve the public's interest in efficient, high-quality rail service.

John E. Kwoka, jr., is Columbian Professor of Economics at George Washington University and Senior Research Scholar at the American Antitrust Institute. Lawrence J. White is Arthur E. Imperatore Professor of Economics at the Stern School of Business, New York University and a member of the Board of Advisors of the American Antitrust Institute.