AAI Criticizes Surface Transportation Board's Railroad Merger Guidelines

Nov 17 2000
Testimony and Interventions

Linda J. Morgan, Chairman
Surface Transportation Board
1925 K Street, NW Washington, DC 20423

Dear Chairman Morgan:

On behalf of the American Antitrust Institute, we are offering these comments in STB Ex Parte No. 582 (Sub-No. 1), Major Rail Consolidation Procedures, issued on October 3, 2000. In these comments we respectfully wish to bring to the attention of the Surface Transportation Board (STB) certain important premises of merger policy and procedures as applied to the general economy that have not played a similar role in either the past or the proposed methodology and approach of the STB for evaluating major rail consolidations. These premises have served general merger policy and the U.S. economy well. The failure to recognize them in the railroad sector, we believe, has ledBand under these proposed procedures, will continue to lead--to losses to the economy, both from a competition standpoint and in terms of the transitional costs of the mergers.

These premises are twofold: First, the methodology employed in evaluating mergers must, to the maximum possible degree, be 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 objectives of the agency and the companies are thus different and often incompatible.

The methodology and approach proposed in this rule-making do not embody these premises. Rather, their core is a set of broad principles, with the real methodology largely unexplained. In addition, the proposal relies on the merging parties to offer information and remedies that are against their own interest. In these crucial respects the proposed procedures are fundamentally flawed and will not result in the protection of consumers and competition in the railroad sector.

The American Antitrust Institute strongly urges the STB to reformulate its proposed policy statement and regulations so that they reflect the fundamental premises of sound merger policy.

The American Antitrust Institute

The American Antitrust Institute is an independent, non?profit education, research and advocacy organization, whose background and prior work products may be found on the Internet at www.antitrustinstitute.org. Since its founding in 1998, the AAI has regularly testified and presented public comments and commentaries on competition policy issues involving both regulated and unregulated industries. Generally speaking AAI favors market?oriented policies that will enhance competition through the active use of antitrust approaches.

The Advisory Board of the AAI includes 45 lawyers, economists, and business experts who are consulted on the activities we undertake, but who do not vote. The signers of this letter are both members of the AAI Advisory Board.

Merger Policy for the Overall Economy

Antitrust policy is rooted in the conviction that competition among independent companies results in an unbeatable combination of low costs and prices, a wide variety of quality products and services, and persistent innovation. Such competition has been essential to the vigor and prosperity that have long characterized the U.S. economy. Economic policy that might have tolerated, much less encouraged, monopolies or highly concentrated industries would indisputably not have a comparable record of performance.

This conviction is embodied in this nation's antitrust statutes -- the Sherman, Clayton, and Federal Trade Commission Acts -- which address "conspiracies in restraint of trade", "monopolization", and mergers that would "substantially ... lessen competition". More than a century of enforcement activity and jurisprudence has given content to these expressed concerns. Moreover, beginning with the 1982 promulgation of Merger Guidelines by the Antitrust Division of the Department of Justice (DOJ) and in subsequent revisions by the DOJ and the Federal Trade Commission (FTC), a specific approach to merger analysis has been articulated. Rooted in economics, this approach involves a five-part process:

  • Definition of the market: essentially, a determination of which sellers have the collective ability to raise price by a significant amount and make it stick.
  • Calculation of seller concentration in the market -- the Herfindahl index -- and the increase in concentration that results from the merger.
  • Analysis of the likelihood, timeliness, and sufficiency of entry, which determine whether or not entrants constrain incumbent firms, plus an examination of other market characteristics that may enhance or inhibit competitive behavior.
  • Articulation of a theory of competitive harm -- coordinated behavior among incumbents or unilateral effects by the merged entity -- from the merger.
  • Evaluation of efficiencies, which must be specific to the merger and must also be passed through to consumers in order to weigh in its favor.

These Merger Guidelines are intended to spell out, with as much clarity and precision as possible, how a merger will be analyzed for possible competitive problems. In this manner the Guidelines systematize the merger evaluation process and push the boundary between rules and discretion as far as possible toward the former. While some discretion in interpretation or weighing of factors may be required, each iteration of the Guidelines has improved their analytical content, objectivity and transparency. Moreover, by placing this methodology in the public domain, the agencies permit private parties contemplating merger to understand the applicable standard and foresee the burden that they will face.

Of equal importance to the Guidelines are the merger review procedures employed by the FTC and the DOJ. Under the Hart-Scott-Rodino Act of 1976, prospective mergers that exceed certain thresholds must be pre-notified to the agencies, one of which takes responsibility for the review. Based on the preliminary information supplied, the reviewing agency makes an initial determination as to whether the merger raises likely competitive issues. If so, a formal investigation is opened, and the agency and the party enter into a process that is partly cooperative and partly adversarial.

The process is cooperative insofar as the agency and the parties to the merger meet and discuss the issues as well as information that might clarify points of disagreement. But importantly, the process remains partly adversarial. The parties understand that they act out of fundamentally different objectives: The merging parties seek higher profits from a stronger market position, while the agency represents consumers= interest in competition and its benefits. While these purposes may coincide to the degree that efficiencies flow from a merger, they are clearly antithetical when a merger results in enhanced market power. The agencies understand that mergers may well be motivated, at least in part, by the firms= desire for market power, and indeed it is only that possibility that requires merger investigations at all.

This understanding conditions the behavior of both sides. Firms have no obligation to highlight areas of competitive concern, and no reason to volunteer information that casts their proposed merger in an unfavorable light. Accordingly, the reviewing agency understands that any information submitted by the parties is subject to the inevitable bias that follows from the parties= private interests. Nor does the agency take at face value any offers by the parties for offsets and settlements of competition problems. At a minimum, such offers often represent the least socially-beneficial alternatives from the set among which the parties may feel compelled to choose in order to attempt resolution of the issues. At worst such offers may be prove to be altogether ineffective in resolving the issues, despite their initial, superficial appeal.

In the background to this interaction is the understanding by both sides that they are prospective opponents in a court of law. And while few mergers actually end up in court, that prospect is a constant reminder of their divergent, and ultimately incompatible, perspectives.

Proposed Merger Evaluation by the Surface Transportation Board

In its proposed modifications to its policy statement (49 CFR 1180.1) and regulations (49 CFR 1180.6) the STB has recognized the importance of competition and the failings -- especially the service failures -- of recent mergers that have been approved by the STB and the Interstate Commerce Commission (ICC) before it. Throughout the proposed statement and regulations, the STB calls for information from the merging parties as to the impact of the merger on competition and the impact on service, as well as proposals to enhance competition and mitigate possible service failures.


  • "merger applications must include provisions for enhanced competition" (proposed '1180.1(c))
  • "the Board expects applicants to propose additional measures that the Board might take if the anticipated public benefits fail to materialize in a timely manner" (proposed '1180.1(c)(1))
  • "Applicants shall propose remedies to mitigate and offset competitive harms" (proposed '1180.1(c)(2)(i))
  • "the Board will require applicants to provide a detailed service assurance plan." (proposed '1180.1(c)(2)(iii))
  • Applicants also should explain how they will cooperate with other carriers in overcoming natural disasters or other serious service problems during the transitional period and afterwards." (proposed '1180.1(c)(2)(iii))
  • "applicants shall explain how the transaction and conditions they propose will enhance competition" (proposed '1180.1(c)(2)(iv))
  • "applicants will be required to propose conditions that will not simply preserve but also enhance competition" (proposed '1180.1(d))
  • "the Board will require applicants to establish contingency plans that would be available to address the negative impacts if projected service levels do not materialize in a timely fashion" (proposed '1180.1(h))
  • "The Board expects applicants to anticipate with as much certainty as possible what additional Class I merger applications are likely to be filed in response to their own application and explain how these applications, taken together, could affect the eventual structure of the industry and the public interest" (proposed '1180.1(i))

While we welcome the recognition implicit in this new proposal of the importance of competition and of the problems that have arisen in the wake of recent mergers, we believe the approach implied by these provisions has fundamental flaws. In some ways the proposal goes too far; in other ways the proposal does not go nearly far enough.

1. The proposal goes too far. The type of information that the STB would be requiring from the applicants is not normally in their interests to provide. The applicants should be expected to be advocates of their merger, not its critics. To expect them to provide such criticisms as well as credible remedies, offsets, and contingency plans for its possible failings is unrealistic. Whatever they provide will, at best, be half-hearted, incomplete, and biased. Treating their submissions as more than that -- more accurate, more impartial, more reliable -- will predictably lead to erroneous decisions.

Put differently, the STB's proposal appears to want to make the merger applicants into allies of the STB in the latter's pursuit of the public interest. This is a misguided effort since the parties= incentives are fundamentally incompatible. The applicants want their merger to proceed and will inevitably provide information designed to portray the merger in the most favorable light. In its pursuit of the public rather than the private interest, therefore, the STB must bring a healthy degree of skepticism to the parties= submissions and representations.

This belief in partnership may be the logical outgrowth of two decades of merger review by the STB and the ICC. During that period the agency=s and companies= objectives largely coincided, as the agency adopted the view that mergers were required to foster the public interest in a financially more secure railroad industry. During this time the companies indeed were partners with the agency in the restructuring process. But the major railroad mergers that have come before the ICC and the STB in the past five years have illustrated the adverse effects of this premise. The railroads have provided assurances that each of these mergers would improve service, achieve cost efficiencies, and preserve competition, all without major transitional costs. At best, the actual results have borne little relationship to the companies' claims, and at worst some of these mergers have wreaked havoc with the nation's transportation system, permanently reducing competition and imposing enormous costs on shippers and customers.

Further, we are concerned about the vague, open-ended, and potentially quite burdensome nature of the information requests. For example, how widely must the parties range in the preparation of their required "provisions for enhanced competition", "contingency plans", and "additional Class I merger applications [that] are likely to be filed"? How far into the range of "unlikely" events must the parties speculate and describe contingencies? For what kinds of "natural disasters and other serious service problems" should they offer cooperative alleviation plans? Should the plans be offered with respect to every origin-destination pair embedded in the merged entity?

We certainly are not objecting to enhancing competition, but we seriously doubt that these procedures will succeed in promoting that end. After all, mergers that truly enhance competition in the sense of lowering price toward and bringing profits more in line with the competitive norm are unlikely even to be proposed by companies. At most, competitively-neutral mergers might be proposed if there are real efficiencies to be secured by the merging companies. A simple requirement that such efficiencies be passed through to consumers (that is, shippers) would be appropriate, but any expectation that the parties will otherwise offer bona fide methods of actually strengthening competition is ill-founded.

We of course recognize that when controversial mergers before the DOJ or FTC require some obvious modifications (for example, bank mergers where some branches in some local markets will have to be sold in order to preserve competition), the merger applicants often propose remedies as part of their negotiations with the agency. But these remedy proposals are understood to be limited in scope and to be part of the advocacy and informal bargaining processes involving the applicants and the agency; they are not considered to be part of the official submissions of the merger applicants. Nor would the agencies be likely to ask the applicants formally to speculate on transition or cumulative effects of mergers or to devise contingency arrangements.

The consideration of alternatives, the devising of remedies, and attempts to anticipate post-merger changes in market structure ought to be primarily the task of the reviewing agency. The agency will, of course try to gain information from the interested parties. But the sources of the information and the motives underlying its provision ought to be recognized. This is best done where this type of information is not part of the initial, standard, formal submissions by the merger applicants.

In addition, because of their vagueness, the STB's requirements might not even achieve the purpose of eliciting the information that the STB desires. We question whether some of these requirements, if imposed on past merger applicants, would have elicited substantially more information than has actually occurred in the recent past. We are most familiar with the Union Pacific-Southern Pacific merger. In that proceeding the UP/SP documents assured the ICC and STB in great detail that substantial efficiencies would be achieved and that competition would be enhanced on most routes. Since they proclaimed that the prospective efficiency gains were so clear and obvious, the UP/SP applicants would not have seen any need for contingency planning. In the few instances where the elimination of competition was so blatant that even the merger applicants could not ignore them, the UP/SP documents proposed remedies (limited trackage rights for BNSF). Except for a requirement that they speculate about future mergers, the UP/SP application might well have passed muster under the STB's proposal.

2. The proposal does not go far enough. Perhaps the most fundamental omission in the STB's proposal is the lack of a framework for analyzing competition and assessing the effects of a particular merger. In short, there is nothing analogous to the Merger Guidelines; indeed, there is no reference to them. Nor is there any separate discussion of the definition/delineation of markets. There is no discussion of seller concentration. There is no discussion of ease or difficulty of entry in its various manifestations, whether through build-outs, build-ins, inter-modal efforts, etc. There is no discussion of the buyer's side of the market and how that may affect competition. Without a more comprehensive and explicit framework, this proposal cannot achieve the objectivity and transparency that has given credence to the Merger Guidelines.

There are numerous specific provisions of the proposed procedures that we would question, but we limit our discussion here to three that illustrate the failure to go far enough. Perhaps the most specific reference to competition in this proposal is the following: "Intramodal competition is reduced when two carriers serving the same origins and destinations merge." (proposed 1180.1(c)(2)(i)) Though we agree strongly with the STB on this point, we are profoundly distressed that even at this late date the STB is not willing to recognize that reductions in the number of carriers from three to two -- and perhaps reductions from larger numbers as well -- may have serious anti-competitive consequences. There is far too little recognition of widespread economic evidence concerning the effects of reducing the numbers of sellers.

A second reference to competition occurs in proposed Sec. 1180.1(a): "the Surface Transportation Board seeks to ensure balanced and sustainable competition in the railroad industry." Unfortunately, the STB never explains what it means by "balanced and sustainable competition". In the absence of any explanation, we fear that the phrase implies that the STB intends to manage the process of competition, rather than trusting to the competitive process itself (and ensuring, through its approach to mergers, that railroad mergers do not create structural conditions that inhibit competition).

Finally, the proposal endorses targeted remedies, such as bottleneck relief and trackage rights, to competitive problems. While these remedies have their roles, reliance upon them to resolve widespread, rather than limited, competitive concerns raises altogether different issues that are not acknowledged in these procedures. For example, trackage rights on routes of several hundred miles are much more subject to being compromised and undermined as competitive enhancements than is true for fifty-mile segments and should not be relied upon, if at all, without added protections. This proposal does not acknowledge these concerns.

For all of these reasons, in order for its commitment to competition to become a reality, the STB must develop and explain its analytical approach, and base it on a recognition of the divergent interests of all parties to a merger.


We applaud the STB for its interest in competition, but the STB's current proposal leaves much to be desired. The proposal asks for the wrong kinds of information from merger applicants, information that will be largely useless -- indeed, perhaps worse than useless -- for an agency that is genuinely interested in competitive issues. And the proposal does not provide enough detail as to what the STB's approach to competitive issues will be.

Accordingly, we urge the Surface Transportation Board to reformulate its proposed policy statement and regulations for reviewing major railroad consolidations so as to be more analytical, objective, and transparent, but also to reflect a recognition that the parties incentives cannot be assumed to be compatible with the purposes of the agency. Only by making these changes will the agency's oversight result in decisions that truly serve the public's interest in efficient, high-quality rail service.


John E. Kwoka, jr
Columbian Professor of Economics, George Washington University
Senior Research Scholar, American Antitrust Institute

Lawrence J. White
Arthur E. Imperatore Professor of Economics, Stern School of Business, New York University
Advisory Board Member, American Antitrust Institute



John E. Kwoka, Jr.

John Kwoka is Columbian Professor of Economics at George Washington University and currently Senior Research Scholar at the American Antitrust Institute. Dr. Kwoka received an AB in Economics from Brown University in 1967 and the PhD in Economics from the University of Pennsylvania in 1972. He has also taught at the University of North Carolina at Chapel Hill and been a visiting faculty member at Northwestern University and at Harvard University.

Dr. Kwoka currently serves as Vice President of the Southern Economic Association and is Co-Director of the Research Program in Industry Economics and Policy at George Washington University. His is a recent past President of the Industrial Organization Society, Guest Scholar at the Brookings Institution, and Fellow in the Kennedy School at Harvard University. Dr. Kwoka has also served in various capacities at the Federal Trade Commission, the Antitrust Division of the Department of Justice, and the Federal Communications Commission.

Dr. Kwoka has written, lectured, and consulted extensively on numerous issues in industrial organization, regulation, and antitrust policy. He has published approximately fifty scholarly articles. His recent books include The Antitrust Revolution (3rd ed., with L. J. White), a compilation of case studies of major antitrust proceedings, and Power Structure, an analysis of electric utility costs and prices. Dr. Kwoka has served or is serving on the editorial boards of four economics journals and is a member of the American Economics Association, the European Association for Research in Industrial Economics, the Industrial Organization Society, and the Southern Economic Association.

Dr. Kwoka consulted on the Union Pacific-Southern Pacific merger and has co-authored a study of it with L. J. White, which appears in The Antitrust Revolution.


Department of Economics
George Washington University
Washington, DC 20052



Lawrence J. White

Lawrence J. White is Arthur E. Imperatore Professor of Economics at New York University's Stern School of Business. During 1986-1989 he was on leave to serve as Board Member, Federal Home Loan Bank Board, and during 1982-1983 he was on leave to serve as Director of the Economic Policy Office, Antitrust Division, U.S. Department of Justice.

Prof. White received the B.A. from Harvard University (1964), the M.Sc. from the London School of Economics (1965), and the Ph.D. from Harvard University (1969). He is the author of The Automobile Industry Since 1945 (1971); Industrial Concentration and Economic Power in Pakistan (1974); Reforming Regulation: Processes and Problems (1981); The Regulation of Air Pollutant Emissions from Motor Vehicles (1982); The Public Library in the 1980s: The Problems of Choice (1983); International Trade in Ocean Shipping Services: The U.S. and the World (1988); The S&L Debacle: Public Policy Lessons for Bank and Thrift Regulation (1991); and articles in leading economics and law journals.

He is editor or coeditor of nine volumes: Deregulation of the Banking and Securities Industries (1979); Mergers and Acquisitions: Current Problems in Perspective (1982); Technology and the Regulation of Financial Markets: Securities, Futures, and Banking (1986); Private Antitrust Litigation: New Evidence, New Learning (1988); The Antitrust Revolution (1989); Bank Management and Regulation (1992); Structural Change in Banking (1993); The Antitrust Revolution: The Role of Economics, 2nd edn. (1994); and The Antitrust Revolution: Economics, Competition, and Policy, 3rd edn. (1999). He was the North American Editor of The Journal of Industrial Economics, 1984-1987 and 1990-1995.

Included in the 3rd edn. of The Antitrust Revolution is the essay "Manifest Destiny? The Union Pacific and Southern Pacific Railroad Merger" co-authored with John E. Kwoka, Jr. Other essays that feature the railroad industry include "The Deregulation of the Telephone Industry: The Lessons from the U.S. Railroad Deregulation Experience," in R. Sato, R.V. Ramachandran, K. Mino, eds., Global Competition and Integration, Kluwer, 1999; and "U.S. Public Policy Toward Network Industries," AEI-Brookings Joint Center for Regulatory Studies, 1999.

Prof. White served on the Senior Staff of the President's Council of Economic Advisers during 1978-1979, and he was Chairman of the Stern School's Department of Economics, 1990-1995.

Stern School of Business
New York University
44 West 4th Street
New York, NY 10012