Academic journal article Contemporary Economic Policy

Mergers, Capital Gains, and Productivity: Evidence from U.S. Telecommunications Mergers

Academic journal article Contemporary Economic Policy

Mergers, Capital Gains, and Productivity: Evidence from U.S. Telecommunications Mergers

Article excerpt

I. INTRODUCTION

In 1997, Bell Atlantic submitted a petition to the New York Public Service Commission seeking approval of (technically, nonintervention in) the proposed Bell Atlantic--Nynex merger. (1) Among the arguments in favor of the merger was that it would achieve a minimum of $600 million in annual cost savings through operating efficiency and economies of scale and scope. The basis for this estimate was not made explicit, but it is consistent with predictions of savings from other mergers in the telecommunications industry.

Regulators, including the Federal Communications Commission (FCC), apparently supported the argument that these benefits from mergers between the regional Bell operating companies (RBOCs) exceeded their costs, that is, possible diminution in actual and potential competition. (2) Accordingly, the Bell Atlantic-Nynex merger was approved on August 1997, just after consummation of the merger between two other RBOC holding companies (SBC Communications and Pacific Telesis). Within three years after these mergers, SBC Communications and Bell Atlantic acquired Ameritech and GTE, respectively. Currently, there are only four RBOC holding companies left in the U.S. local telecommunications markets.

This study attempts to answer the following questions: Did merged companies perform better after than before merger and better than nonmerged companies? Were the cost savings realized as promised? In particular, the study analyzes the effects of the first two horizontal mergers between RBOC holding companies, the SBC--Pacific Telesis merger and the Bell Atlantic--Nynex merger, on the performance of the respective local operating companies. The effects of the mergers are examined by comparing the performance of the merged companies with control groups of nonmerged companies and also the performance of the merged companies before and after merger. In this sense, the study is a dynamic analysis of mergers. The comparisons are made on total factor productivity (TFP) change, on shifts in the total cost function, and also on shareholder returns. In addition, the estimation of total cost functions provides estimates for economies of scale and scope, which are often cited as the main drivers for mergers.

The study differs from previous studies on mergers in that it attempts not only to measure the underlying value creation (or destruction) resulting from mergers but also to determine whether the expected capital gains are actually realized. In addition, the study attempts to improve on the evidence from accounting measures of profitability, such as returns on assets and operating income, by examining detailed information on productivity and efficiency change. In carrying out the analysis, the authors attempt to allow for the effects of incentive regulation, such as price cap regulation. Similarly, they attempt to distinguish the effects of mergers from those of changes in local competition following the Telecommunications Act of 1996.

In sum, the intrinsic importance of the industry combined with the fact that the merging companies account for a significant fraction of its output renders the analysis of obvious policy relevance. Moreover, these mergers may well be precursors of proposals for future mergers in the industry. But beyond the policy implications, the article purports to make some methodological advances.

Past studies of the success or failure of mergers have focused primarily (though not exclusively) on short-term stock market returns to acquirers and to shareholders of target firms. Detailed surveys of this literature are to be found in Andrade and Stafford (2001), Bradley et al. (1988), Jarrell et al. (1988), and Mueller (1997). To these authors' knowledge, this is the first study of mergers to combine the analysis of real variables, such as productivity and costs with the analysis of stock market returns. Second, stock market returns are examined for multiyear intervals as well as for short periods following merger. …

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