Shorting Your Rivals: Negative Ownership as an Antitrust Remedy

Introduction

The merger of rivals often raises the concern that lost competition will result in higher prices or other harms. In anticipation of a government antitrust lawsuit seeking to block such a deal, the merging parties typically offer a solution that avoids the anticipated anticompetitive effects. The goal is to restore competition to the level that would exist absent the merger.

A standard regulatory response is divestiture: to require merging firms, as a condition of merger approval, to sell assets within the areas of competitive overlap. For example, suppose that two grocery chains propose to merge, and that competition is highly localized. The parties might offer to sell every store of firm 2 that is located within two miles of a store of firm 1. The animating idea is to eliminate the competitive concern—or at least to reduce it enough to discourage the government’s suit—without also destroying any procompetitive rationale for the deal. Divestiture is not the only merger remedy, but the alternatives have various problems that make their imposition ineffective or impractical, and agencies seldom accept them.

In many cases, however, there is no divestiture that would restore competition. Competition in many industries does not resemble our grocery store example. Consider, for example, the recently blocked merger between JetBlue Airways and Spirit Airlines. In airlines, the network economies of provision tend to make piecemeal divestitures ineffective. In other industries, ranging from wireless telephony to health insurance to the distribution of food and office supplies, some customers seek products and services that are national in scope. In this setting, too, piecemeal divestiture does not work, because such a divestiture is not sufficient to result in a competitor strong enough to maintain the pre-merger level of competition.

Divestitures have other shortcomings. Even where they are effective in removing or reducing the anticompetitive effect, they often also undermine the procompetitive rationale for the deal. For example, a grocery merger might lower local inventory costs, a benefit that is undermined by requiring divestitures in overlapping geographic markets.

The inadequacy of existing remedial tools is a well-recognized problem with important consequences. When effective divestiture is not feasible, antitrust authorities confront the all-or-nothing dilemma of approval or denial. The Department of Justice and Federal Trade Commission have brought major enforcement actions to block challenges in industries where effective divestiture was infeasible, typically (though not invariably) resulting in an abandonment or failure of the transaction. Other transactions are not even attempted because there is no workable divestiture strategy. As a consequence, potentially important efficiencies are never achieved. In still other mergers, antitrust authorities have chosen to accept the bitter (some upward price pressure) alongside the sweet (procompetitive benefits) and allow potentially harmful mergers to proceed. In all of these instances we ought to prefer an alternative that achieves the potential efficiency benefits with less public harm.

In this article, we propose the use of an alternative remedy: for the merged firm to take negative ownership positions in its remaining rivals. The simplest form of negative ownership is for the firm to take a short position. For example, as a condition for JetBlue’s merger with Spirit, the combined firm might be obliged to take a short position in American, United, and Delta Airlines.

The negative ownership remedy does not require taking a short position. As we explain, there are various ways to implement the remedy. For example, the managers of a merged JetBlue/Spirit might have been required, as a precondition of merger approval, to be paid under a new compensation scheme keyed to the merged firm’s performance relative to that of its major rivals. Negative ownership can alternatively be implemented through the sale of derivatives or bespoke contracts that have other attractive features, alongside serious implementation challenges, as we explore in greater detail below.

The negative ownership approach represents a different kind of divestiture. Instead of requiring merging firms to divest themselves of their interest in overlapping assets, our proposal would require merging firms to divest themselves of what would otherwise be an economic interest in raising their profits in a manner that also increases the profits of their unmerged rivals. Instead of requiring long selling of certain assets, our proposal would require short selling of other assets.

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