Efficiency versus market power in mergers: Evidence from the airline industry.

Abstract

Previous studies in the finance literature testing for the role of market power in mergers suffer from two major limitations. First, the analyses draw their conclusions based exclusively on capital market data although capital market data are ill-suited for testing of market power. Second, the samples are drawn from an environment where a stringent antitrust policy makes it more costly for market-power increasing mergers to take place. This environment makes the finding of "market power-motivated mergers" less probable. In this thesis, significant reliance is placed on the behavior of product prices to test for market power. However, use of product prices requires that other factors influencing prices be accounted for. Other factors are controlled by considering changes in prices relative to a reference group, which is not affected by the merger. Moreover, relaxation of the antitrust policy, as applied to the airline industry, ensured that no airline merger proposals were denied during the mid eighties. Therefore, market power-motivated mergers could (and did) take place. The thesis develops hypotheses to evaluate the role of market power in mergers and tests them by investigating the effect of mergers on (i) the merging firms' airfares in the product market and on (ii) abnormal returns to merging firms in the stock market. Since exercise of market power affects other airline firms in the market, the analysis is extended to study the effect of mergers on (iii) rival firms' airfares and on (iv) abnormal returns to rival firms. Various tests provide strong support for the hypothesis that market power was a motivation in airline mergers. The product market tests show that market power is exercised even before final approvals are granted by the regulatory agencies. There is also strong evidence to suggest that market power derived from multimarket contact, increased as a consequence of airline mergers. The capital market tests provide weaker support for the market power hypothesis.