Beware of consultants bearing rosy news about mergers

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mid the blizzard of election news last November, two writers at the nonprofit news organization ProPublica came out with a startling investigative report. Jesse Eisinger and Justin Elliott wrote about a small but very wealthy group of American economists who make millions of dollars helping companies deal with the federal government on antitrust cases.
They focused on Dennis Carlton, a professor at the University of Chicago’s Booth School of Business, and a senior managing director at the consulting firm Compass Lexecon. According to Eisinger and Elliott, Carlton has been paid more than $100 million from consulting activities during his career.
That’s an astounding sum, and it demonstrates how lucrative the economics profession can be for those who reach the top echelons. But the ProPublica reporters suggest that much of this fortune may have been made at the public’s expense. Carlton and economists like him are mostly hired by companies that want to do big mergers and acquisitions. This basically involves convincing the government — which reviews all large corporate acquisitions — that the merger won’t hurt consumers.
Mergers can hurt consumers by giving companies increased market power. The less competitive an industry is, the more the big companies can raise prices, which not only makes life more painful for consumers, but limits the size of the market itself, reducing economic productivity. Any time two companies want to merge, there’s the possibility that the result could be a more efficient company, which would lead to lower prices as production costs decline. But there’s also the possibility of a less efficient market, where prices rise because of increased monopoly power. You need economics to predict which of these will happen.
Obviously, if consultants like Carlton are being paid by the companies that want to merge, they have an incentive to use economics to predict a rosy outcome instead of a bad one. But how easy is that? In an ideal world, it would be very difficult to get away with using economic models to make slanted forecasts. If a certain type of model repeatedly got things wrong in biology or electrical engineering, professors would toss it out, and it would probably no longer be used in most court cases.
Econ is different. Despite a recent turn away from pure theory and toward empirical work, the profession doesn’t always insist on the most rigorous standards of evidence. Economists Joshua Angrist and Jörn-Steffen Pischke have criticized the field of industrial organization, which deals with competition and monopoly power. They say that it still relies on obsolete theoretical models laden with questionable assumptions.
Does this mean that the theoretical models used by merger consultants like Carlton are wrong? Not necessarily. It just means that it’s very hard to know either way. As Eisinger and Elliott demonstrate, however, the models have been known to make some pretty big mistakes. One example they cite is the merger of appliance makers Maytag Corp. and Whirlpool Corp. in 2005. Carlton, hired by those companies, wrote that international competition would prevent the new super-company from raising prices. But he was wrong, and prices
went up.
This sort of result seems to be the norm in recent years. Northwestern University economist John Kwoka has written an entire book in which he documents how lax US antitrust policy has resulted in less competition and higher prices — the kind of thing the high-flying consultants are paid to say won’t happen.
The threat of excessive industrial concentration is worth paying more attention to. Economists increasingly are focusing on the harms that monopoly power might be causing. In addition to the well-known effect of higher prices, industrial concentration might exacerbate inequality and decrease labor’s share of national income. It might also be reducing business dynamism, which has taken a dive since 2000.
So it probably makes sense to take a harder look at antitrust policy in general and merger consultants more specifically. The US system may simply be too lenient. It may rely too much on the testimony of well-paid experts, who are able to use their models to reach the desired conclusion. One solution might be for the government to review the predictions of expert consultants, and see whether they end up being right or wrong — something that Eisinger and Elliott say isn’t done now. The results of these follow-up studies could be made public, so courts and regulators know the track record of a given model or consultant.
That’s just one possibility. Any solution to this problem, though, should follow the principle of greater empiricism. The more weight is given to evidence, and the less to theoretical assumptions, the better it will be for the American consumer. Economics is becoming more empirical, and the lucrative world of legal consulting should follow suit. —Bloomberg

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion

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