Rethinking efficiencies (part 3 of 3) – Verifiability in an uncertain world

Authors: Will Leslie, Eoin O’Reilly, Claire Tobijanski

As we approach the publication of the draft merger guidelines, the noise has verifiably increased. Reports suggest a potential sea change for EU merger control.

This promised new reality brings us to the third part of our series on efficiencies – verifiability. Efficiencies only matter if they are verifiable. Even where the merging parties invoke merger specific efficiencies which benefit consumers, the Commission will not credit them unless it is “reasonably certain” that they will materialise, and they are verifiably substantial enough to offset harm.

One might argue that, in today’s world, attempting to prove that any future event is “reasonably certain” is a fool’s errand. Indeed, while short-term pricing efficiencies might be more easily verified, non price and long-term efficiencies fit much less comfortably within this framework. The 2004 guidelines provide that the probability of long-term efficiencies should be discounted, which in practice means the Commission can rarely (if ever) be “reasonably certain” that they will materialise and thus they are not considered at all.

Similarly, faster innovation and roll out, higher quality, environmental gains and greater resilience are harder to prove and quantify than short-term price effects. As AG Emiliou noted in RRC Sports, “when efficiency gains arise from measures furthering technical or economic progress, it may be outright impossible to translate that progress into a precise monetary value”. Yet, while the Commission has considered efficiencies relating to technical progress and environmental benefit, arguments have often failed as not sufficiently substantiated, verifiable or quantifiable.

Merging parties have historically been expected to overcome uncertainty with precise quantification and without reference to long-term efficiencies, even though, on the other side of the scale, the Commission increasingly relies on theories of harm based on scenarios and predictive judgement. Showing that harm is more likely than not is sufficient for the Commission to meet its burden of proof. Balancing long-term effects against short-term effects is not a straightforward task in either situation, but there is little reason why long-term efficiencies should be excluded from the equation if the same is not true of equivalent harms. The non-horizontal merger guidelines suggest greater parity in the framework of assessment between efficiencies and harms that does not always play out in practice though.

The balancing exercise is perhaps better approached through a holistic review of a body of evidence, including more uncertain harms and efficiencies. Thus, where the evidence supports the potential for long-term efficiencies, it is reasonable to discount, but not discard, uncertain benefits. A balanced approach would also align, insofar as possible, the evidentiary threshold for efficiencies with that used for harm and tailor expectations to the type of benefit claimed. The same categories of evidence that are used to substantiate a significant impediment to effective competition should, in principle, be available for efficiencies: internal documents, market data, third party evidence and expert analyses.

For standard cost synergies, robust quantification can still be expected. For example, for innovation, resilience, infrastructure investments and sustainability benefits, a different evidential mix would be more realistic. This may include internal documents, expert analysis, and the use of ranges and scenarios rather than a single figure. Precise quantification should be viewed as helpful, not essential, and should not set a bar so high that it is practically unachievable.

The starting point should be what businesses themselves use to justify the deal: board papers, synergy cases, internal forecasts and implementation plans. It is fair for the Commission to expect that the parties have done their homework carefully if they want to rely on offsetting benefits to explain the deal to the regulators (and, indeed, customers and other stakeholders). These materials already play a central role in the Commission’s harm analysis in cases such as Deutsche Börse/Euronext, Ineos/Solvay/JV, and GE/Alstom. Where those materials consistently show that the merger is justified by specific efficiencies, that should strongly support a finding that the efficiencies are likely, even if their exact impact is uncertain.

External and historical evidence should reinforce this picture, not be dismissed as “soft”. Management and investor communications can show that efficiencies are part of the real business rationale, not just an attempt to justify the merger. Past integrations by the same firms or comparable transactions provide data on what has been achieved before. The lack of perfect precedents should not be treated as a reason to ignore efficiency claims in novel deals; these are often precisely the cases where efficiencies matter most.

Finally, verifiability should be more clearly tied to who bears the evidentiary burden. Parties must still present detailed, evidence-based efficiency claims. They bear the burden of providing the evidence relevant to the analysis. However, once they have put forward a coherent, documented story that fits their internal rationale and is backed by proper analysis, the Commission should be prepared to use its investigative powers to test it and gather further evidence from customers and other stakeholders, rather than dismiss without its own investigation. Equally, further investigation may show the claimed efficiencies do not stack up. If there is still a high degree of uncertainty that these benefits will materialise (in particular if they involve investments to be carried out), the Commission can also request that the parties offer commitments to assure that the efficiencies are verifiable (e.g., commitments on efficiency).

Verifiability is undeniably important – the Commission must distinguish credible, merger driven efficiencies from wishful thinking – but the standard of proof is critical. If businesses only made investment decisions when they were “reasonably certain” of outcomes, the economy would stagnate. Equally, the Commission’s merger reviews should allow for some uncertainty in the pursuit of progress.