Do Incumbents’ Mergers Influence Entrepreneurial Entry An Evaluation (pages 601–633)
& Mergers Influence
Entrepreneurial Entry? An Evaluation
Sumit K. Majumdar Rabih Moussawi Ulku Yaylacicegi
This analysis has evaluated the impact of mergers on new entrepreneurial firm entry in the territories of firms making up the local exchange sector of the United States telecommuni- cations industry. An analysis of first and second mergers undertaken by the local exchange companies has revealed that where mergers occurred there was significantly lower entre- preneurial entry. The results have implications for policy, since the approval of mergers has been shown to lead to lower entrepreneurial entry where mergers occur, and the approval of mergers may serve to impede entrepreneurship. Hence, greater thought should be given to merger approvals so that entrepreneurship and the process of economic growth are not compromised as a result.
Introduction
In the United States, numerous incumbent local exchange carrier (ILEC) mergers have taken place in the telecommunications sector. These ILEC mergers were approved by the Department of Justice and the Federal Communications Commission (FCC). Their approvals have been consequential. One such consequence has been the consolidation of the local exchange sector. Simultaneous institutional changes have brought the presence of horizontal competition in ILECs’ territories. The landmark Telecommunications Act of 1996 encouraged entry of new entrepreneurial firms to become horizontal competitors in the franchised territories of the ILECs.
This study evaluates the impact of the various approved mergers on new entrepre- neurial firm entry in ILECs’ territories in the United States. The analysis conducted strips out the impact of the Telecommunications Act of 1996. As a major institutional change, impacting industry structure, this legislation exogenously encouraged entry by potential competitors, as meant to by lawmakers. Controlling for other factors, the issue evaluated is whether after the approved mergers undertaken by the ILECs, there has been entry of
Please send correspondence to: Sumit K. Majumdar, tel.: 972-883-4786, e-mail: Majumdar@utdallas.edu, to Rabih Moussawi at Rabihm7@gmail.com, and to Ulku Yaylacicegi at yaylacicegiu@uncw.edu.
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A sizable portion of contemporary entrepreneurship research lies at the intersection between strategic management and public policy (Levie & Autio, 2011; Minniti, 2008). Entrepreneurs are considered the prime drivers of economic progress (Hughes, 1986; Leff, 1979), as they pursue opportunities, create competitive advantage (Ireland, Hitt, & Sirmon, 2003), and contribute to economic growth. Yet, they are subject to considerable contextual influences (Davidsson & Wiklund, 2001; Shane, 2003; Shane & Venkataraman, 2000). Social and political contexts influence entrepreneurs’ attitudes, allocation of efforts, levels of resources to be mobilized, and dictate the constraints impinging on establishing an enterprise (Bowen & De Clercq, 2008; Harper, 1998; Martinelli, 2004). Consequently, the policy context materially impacts the nature, direction, rate, and extent of entrepreneurship (Welter & Smallbone, 2011).
In the last decade, a stream of literature has emerged suggesting that institutional factors prominently exercise contextual influence (Boettke, 2001; Wennekers & Thurik, 1999). Institutional factors order reality by providing meanings for actions (Thornton & Ocasio, 1999); but they also influence business outcomes (Meyer & Rowan, 1991) across regions (Reynolds, Miller, & Maki, 1995). Specifically, legal and regulatory institutional decisions, as described by North and Thomas (1973) and Olson (1982), materially influ- ence entrepreneurs’ perceptions, behavior, and performance (Baumol, 1990; Capelleras, Mole, Greene, & Storey, 2008; Olson, 1996).
Entrepreneurial decisions are influenced by institutional decisions because such deci- sions directly impact the generation and distribution of returns to entrepreneurship (Autio & Acs, 2010; O’Brien, Folta, & Johnson, 2003). Institutional decisions define rules of the game, provide a framework to guide activity, remove uncertainty, ensure action predictability, and reduce transactions costs (North, 1990), and the institutional decision- making environment can create or destroy entrepreneurship within a country (Aldrich & Wiedenmayer, 1993). 1
A critical institutional factor affecting entrepreneurial behavior has been public policies and regulations with respect to entrepreneurial firm entry (Djankov, La Porta, Lopez-de-Silanes, & Shleifer, 2002). The entrepreneurship (Davidsson, Hunter, & Klofsten, 2007; Davis & Henrekson, 1999; Sørensen, 2007) and allied literatures (Audretsch, van Leeuwen, Menkveld, & Thurik, 2001; Bertrand & Kramarz, 2002; Klapper, Laeven, & Rajan, 2006) evaluates how entry of new firms is affected by insti- tutional factors. The broad finding has established that costly regulations, leading to higher entry costs, dampen entrepreneurial behavior and stifle growth.
In many sectors, mergers of large firms are regulated by competition policy authori- ties. Public policy decisions, as to whether to allow mergers between large incumbent firms, have a bearing on the nature of the competitive playing field. Approval of such mergers can promote or deter new firm entry. A small theoretical literature, aimed at developing policies as to whether mergers should be approved or not, evaluates the impact
1. Alternative institutional decision regimes affect entrepreneurial behavior heterogeneously, and this effect can occur through the prohibition of certain transactions or the failure to enforce rights or rule of law. Also, enterprise development and economic growth may be constrained by government corruption (Frye & Shleifer, 1997; Shleifer & Vishny, 1994), inappropriate taxation or regulations (Johnson, Kaufmann, & Zoido-Lobaton, 1998), and inconsistent monetary and fiscal policies. Other institutional factors influencing entrepreneurship include credit constraints (Aghion, Fally, & Scarpetta, 2007) and labor laws (Botero, Djankov, La Porta, Lopez-De-Silanes, & Shleifer, 2004).
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The conceptual literature, related to the topic of mergers and firm entry, does not contain clear propositions. Stigler (1950) had suggested that large incumbents’ mergers would trigger new firm entry. Therefore, mergers ought to be approved. This has been the dominant logic behind the policy of merger approval in the United States (Coate, 2008). Yet, mergers between firms in an industry sector create important entry barriers (Baker, 2003), and mergers can be used as an entry deterrence strategy to thwart entrepreneurial firms’ entry. Thus, an institutional decision by-product, to permit large incumbents’ mergers, can be the slowdown of entrepreneurship in an economy.
While several theoretical analyses (Cabral, 2003; Marino & Zabojnik, 2006; Pesendorfer, 2005; Spector, 2003; Werden & Froeb, 1998) have generated conflicting results, a key analysis has established that mergers did not induce new entrepreneurial firm entry (Werden & Froeb). Therefore, approvals for large firm mergers should
be sparsely given. Yet, U.S. courts have rejected challenges against the approvals of large firm mergers. They have approved numerous recent large firm mergers on the grounds that contemporary markets are contestable, and new entrepreneurial firm entry triggered by mergers will constrain any subsequent anticompetitive effects (Davidson & Mukherjee, 2007).
But, have these grounds for institutional merger approbation been valid? In spite of the considerably important role that mergers play in shaping industry structures, competi- tive conditions and entrepreneurial behavior, little evidence exists about whether new firm entry has occurred after mergers. Empirical analysis of new firm entry, after the approval of incumbent firms’ mergers, is negligible. Just one study (Berger, Bonime, Goldberg, & White, 2004) has evaluated the dynamics of approved and consummated mergers on new firm entry, for the banking industry. A positive result was noted. The lack of evidence on the topic is a major lacuna, given the role that mergers are assumed to play in engendering new firm entry. This analysis adds to the corpus of evidence.
Impact of Mergers on Entry
Early Thinking on Mergers and Entry
It is useful to articulate a simple model explaining the link between mergers and entry. There are contending perspectives on the impact of mergers on entry. The literature on entry barriers commenced with Bain (1956). Such entry barriers were engendered by advantages incumbents held over entrants, and allowed prices to be above competitive levels. The main entry barriers were scale economies, capital requirements, product differentiation, and cost advantages. These acted to exclude new firm entry.
Further developments of the theory of entry barriers owed much to the debates between Bain (1956) and Stigler (1968). Stigler (1950) changed the focus of analysis from profits to costs. He defined entry barriers as the costs of production likely to be borne by new entrants, but not incumbents. With respect to post-merger new firm entry, provided such entry was free and costless, the anticompetitive effects of mergers would be wiped out by new competition (Stigler). Thus, Stigler recommended approving incumbents’
2. Each topic, of mergers, and of new firm entry, has been subject to considerable separate analyses.
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In later writing, Stigler (1968) stated that incumbent firms’ capabilities would lead them to create entry barriers. These entry barriers were organizational and outcomes of incumbents’ superior performance. Firms’ actions led them to achieve superior market and resource positions protected by entry barriers. While such incumbent-created barriers might deter entry, from a policy point, incumbents’ mergers could be approved since barriers were endogenously created. 4
The literature is unclear as to why mergers are entry inducing or deterring. Hence, further conceptualization is useful. Mergers are typically driven by the search for syn- ergies and scale economies (Brush, 1996; Farrell & Shapiro, 2001; Pitofsky, 1999). A
desire for cost savings typically lead incumbent firms to merge. 5 By announcing and consummating such mergers, the merging firms signal that their cost structures have been uncompetitive. In a dynamic technological environment, where cost structures keep shifting consistently downward, because of innovations and learning economies, entry motivations would exist because new firms’ cost structures could be lower than that of incumbents.
Such newly entering firms would be more efficient than older incumbents because of the possibility of larger and older firms becoming inefficient with age (Hill & Kalirajan, 1993; Nguyen & Reznek, 1991; Schmalensee, 1989). These new firms would be able to supply consumers with items at lower prices. In addition, incumbent firms could also be interested in acquiring the efficient entrants in order to augment sources of cheap supply. Thus, incumbents could signal to an entrant that a future sellout, by merger, to an incumbent would be a viable exit strategy increasing the expected net present value of entry. Hence, positive entry of new entrepreneurial firms would occur after incumbents’ mergers were approved and consummated.
Alternatively, incumbents’ mergers could negatively affect entry. Generally, numerous factors would increase the length of time for new entry to restore a competitive equilib- rium after structural adjustments such as mergers (Posner, 1976). An entry deterrence strategy adopted by incumbents could be mergers. The possibilities of delays in the subsequent long run structural adjustment process could signal to entrants the incumbents’ possession of potential aggressive intents as well as resources to wait for favorable
3. Stigler (1950) assumed that potential new firm entry would exercise competitive pressures on incumbents to not engage in anticompetitive acts. Entry by new firms was a disciplinary device signifying the dynamics of a working competitive economy.
4. Extending the Stigler (1950, 1968) point of view, Williamson (1968) suggested that antitrust concerns arising from mergers could be obviated if merger cost savings were larger than allocative inefficiencies. Even small levels of cost savings could offset distortions arising from the exercise of market power. These would lead to net welfare gains. Williamson, therefore, suggested that merger approvals be given even if new firm entry were to be foreclosed. The critical assumption was the generation of dynamic efficiencies as a result of mergers. These dynamic efficiencies would arise because of the harnessing of capabilities (Stigler) and the acquiring of scale and scope economies via mergers. Capability harnessing and generation of dynamic efficiencies would make the allocative inefficiencies that were generated (Bain, 1956) less onerous. Dynamic efficiencies would make the merged incumbent firms formidable competitors, leading to less new firm entry as the outcomes of incumbents’ retaliatory threats could be negative.
5. This motive has been extensively documented (Goldman, Gotts, & Piaskoski, 2003) for the telecommu- nications sector.
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Later Development of Ideas 6 Additional ideas have sharpened the relationships between mergers and new firm
entry. Incumbent firms create entry barriers by large investments in assets that become sunk (Gilbert, 1989). A firm with large sunk costs would, in the face of likely entry, engage in strategic deterrence activities (Salop, 1979) to protect its position. An incumbent could protect itself by merging with others, creating a large sunk cost pool, and making the replication of resources by entrants difficult. A committed new entrant would have to enter at a large scale to match merged incumbents in size. If a new firm entered at a suitable scale, the large output volumes generated by the incumbent(s) and the new entrant together would depress prices and make a new entrant’s finances unviable. 7
Sunk costs, as ancillary barriers, would reinforce the deterrent effects of mergers by creating higher uncertainty levels 8 and magnify risk (Carlton & Perloff, 1994). Thus, incumbents’ mergers would act as entry deterrents. If entry required large sunk costs, 9 the
6. The contemporary industrial organization literature does not evaluate entry incentives, per se. It simply takes entry by new competitors as given. There are very few mentions in the literature about incumbents’ creation of entry barriers. The aim of contemporary economic analysis is to evaluate the consequences of entry on merger outcomes. Davidson and Mukherjee (2007) suggest that, with moderate cost synergies, mergers of
a small number of industry participants are beneficial. Werden and Froeb (1998) establish that, in the absence of synergies, a merger followed by new entrepreneurial firm entry is unprofitable for the merging firms and to be profitable mergers must lead to raised prices. Spector (2003) shows that a profitable merger, where synergies are absent, raises price even if new entrepreneurial firm entry occurs. Cabral (2003) restates ideas suggesting post-merger cost efficiency possibilities will decrease entry likelihood. Marino and Zabojnik (2006) reverse the dynamics to suggest that if entry is easy, and entrants exert competitive pressure on the merging firms, then merging firms will be driven in their merger decisions by a search for efficiency as opposed to being driven by motivations to increase market power. Pesendorfer (2005) shows that after an initial merger, if new entrepreneurial firm entry occurs, a strategy for incumbent firms to cope with new competitors is to buy them up. If entrants can be further acquired, in a series of sequential mergers, then the initial merger decisions may be profitable. Such predatory acquisitions by incumbents could have two effects on entry. A number of entrepreneurial firms might enter, hoping to be bought by the incumbents so that founders could cash out quickly. Larger entrants might resist entry if being acquired was a possibility that would cause loss of entrepreneurial or managerial independence.
7. Large capital investments would discourage entry by magnifying risks. If a new entrant wanted to enter a sector at the same scale as that of the incumbent, it would have to replicate the sunk costs. This would mean replicating the resources required. Most new firms could pay large capital costs if entry were profitable. If, however, entry required large sunk costs and the entrant were unsuccessful, its losses would be large.
8. Uncertainty itself was an ancillary barrier, in turn reinforcing the deterrent effects of sunk costs. Sunk costs, both experienced by merging incumbents and likely to be faced by entrants, in combination with the associated uncertainty created, could cause firms to delay or avoid entry (McAfee, Mialon, & Williams, 2004). In the presence of sunk costs and uncertainty, as ancillary barriers to entry, combining and reinforcing each other to delay new firm entry, incumbents’ mergers would produce a barrier to entry by new firms.
9. Recent research (Lim, Morse, Mitchell, & Seawright, 2010; Mitchell, Smith, Seawright, & Morse, 2000; Mitchell et al., 2002) has examined the process of how the institutional environment impacts entry into new ventures. Entrepreneurs have knowledge structures different from those of others, and these differences influence entry into new ventures (Baron, 2000). An aspect of difference is in risk perception (Keh, Foo, & Lim, 2002). The presence of sunk costs and uncertainty, as ancillary barriers to entry, can create structural risk (Pindyck, 2009).
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Context Evaluated
Institutional Changes
Given the issue being examined, the context is very important. The industry had been historically competitive, with new firm entry, but evolved into a regulated monopoly. The last 20 years have seen fundamental structural changes in the telecommunications sector. After the issue of a Modification of Final Judgment (MFJ) in 1982, and pursuant to a consent decree, in 1984 AT&T divested its local telephone companies, called the Bell
Operating Companies (BOCs), and retained long distance services. 10 Twelve years after the 1984 divestiture, the Telecommunications Act of 1996 again recast industry structure to make it competitive (Cave, Majumdar, & Vogelsang, 2002). 11 This structure-changing legislation was intended to bring competition into a sector monopolized by ILECs. Hence, the impact of this legislation would be to induce entry in incumbents’ markets.
Competitive local exchange carriers (CLECs) were defined as incumbents’ rivals, or firms that entered local phone markets after divestiture. The Telecommunications Act of 1996 and the FCC Report and Order of 1996 led such firms to enter the local telecom- munications market in three ways. First, CLECs could purchase a local service at whole- sale rates and resell it to the end users. These CLECs were classified as resellers. Second, they could lease various unbundled elements of an incumbent’s network through coloca- tion. These CLECs were classified as service providers. Third, they could set up networks as facilities-based competitors.
The emergence of new firms was profound (Loomis & Swann, 2005), based on trends noted for the late 1990s and early 2000s (Koski & Majumdar, 2002). Accessing the incumbent’s network operations as a reseller was a minor way to enter local markets. Only 1.7% of the total lines installed by ILECs were subject to reselling at the end of the 1990s. Even less leasing of unbundled local loops took place. Only 0.2% of the ILECs’ loops were leased. Conversely, the CLECs concentrated their efforts on network building to provide infrastructure-based competition. Between the mid and late 1990s, the CLECs
10. In 1984, 22 BOCs were in existence, and 161 local access and transport areas (LATAs) were created. The BOCs were permitted to carry calls originating and terminating in one LATA. 11. The objectives of the Telecommunications Act of 1996 were: “To promote competition and reduce regulation in order to secure lower prices and higher quality services for American telecommunications consumers and encourage the rapid deployment of new telecommunications technologies.” The legislation had recognized the telecommunications network as a network of interconnected networks, and existing service providers were required to interconnect with entrants at any feasible point the entrant wishes. The legislation required incumbent local exchange carriers to lease parts of their network, as unbundled network elements, to competitors at cost, to provide at wholesale prices any service the firms provided to competitors and to charge reciprocal rates in termination of calls to their network and to the network of local competitors. The passage of the Act could have fundamental impact on entry conditions (Lehman & Weisman, 2000).
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Mergers in the Sector
The detailed flow of mergers and their approvals in the sector are described next. In 1984, with the break-up of the old AT&T, the sector consisted of seven Regional Holding Companies (RHCs), which between them owned 22 stand-alone Bell Operating Companies (BOCs); an example of one was New England Telephone, which was owned by NYNEX, the relevant RHC. There were five other such groupings, namely Central Telephone, Continental Telephone, GTE, Southern New England Telephone, and United Telephone, and two large independent companies, namely Cincinnati Bell and Rochester Telephone. In total, these groupings owned several ILECs. Of these, just over
40 accounted for well over 95% of the lines. 12 Table 1 lists each company’s situation, over the period analyzed, in terms of owner- ship status and merger activity. In the early 1990s, several RHCs amalgamated their separate stand-alone local exchange companies. Two examples follow. In 1991, the operations of Mountain States Telephone and Telegraph Company, Northwestern Bell Telephone Company, and Pacific Northwest Bell Telephone Company were combined to form US West Communications. In 1992, the amalgamation of South Central Bell Telephone Company and Southern Bell Telephone and Telegraph Company operations, as Bell South, took place. These companies were regulated, by state agencies, in specific territories they operated in.
Simultaneously, several non-RHC groupings, which did not have adequate resources, or were territorially disparate, were acquired by other groupings. Thus, Continental merged its companies, such as Contel of California, Contel of New York, Contel of Virginia and Contel of Texas with GTE. These mergers occurred in 1990. Thereafter, the operating companies belonging to United were acquired by Sprint in 1991, and the Central Telephone Company was acquired by Sprint in 1992.
A spate of mergers occurred in the mid 1990s. The landmark Telecommunications Act of 1996 opened the local exchange market to entry by competitive local exchange carriers. This motivated a series of initial performance-enhancing mergers among unattached RHCs. For example, Pacific Telesis, under financial strain in its California operations, was acquired and merged with Southwestern Bell Corporation (SBC) in 1997. SBC also acquired Southern New England Telephone (SNET) in 1998. In addition, intermodal cable competition emerged. The erstwhile AT&T, the long-distance company, had purchased several cable companies, such as TCI, Media One, and Lenfest by 1999. It had also purchased the downtown Boston assets of Cable Vision. All of these had cost well over $100 billion. The AT&T cable business could provide very substantial competition to the incumbents.
Several RHCs began acquiring other RHCs or other groupings. Ameritech was acquired by SBC in 1999 so as to acquire the financial scale to be a player with major presence in all local exchange markets across the United States. Then, in 2000 GTE was
12. The local exchange sector actually consists of several thousand firms, if all of the rural telecommunica- tions companies in the United States are included, but less than 50 of these largest operating companies accounted for 99% of the lines.
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Table 1 Status of Firms and Merger Activity in the Local Exchange Sector of the U.S.
Telecommunications Industry
This table describes the entire corpus of M&A activity for the population of the local exchange telecommunications companies including change in ownership, merger, or acquisitions
Company names
Status 1988 to 1995
Status 1996 to 2001
Illinois Bell Telephone Company † Indiana Bell Telephone Company Inc. †
An original Ameritech company
Became a part of SBC in 1999
Became a part of SBC in 1999 Michigan Bell Telephone Company †
An original Ameritech company
Became a part of SBC in 1999 The Ohio Bell Telephone Company † †
An original Ameritech company
Became a part of SBC in 1999 Wisconsin Bell Inc.
An original Ameritech company
Became a part of SBC in 1999 Chesapeake & Potomac Telephone Company †
An original Ameritech company An original Bell Atlantic Company which
An original Bell Atlantic Company which
became Verizon in 2000 Chesapeake & Potomac Telephone Company of
became Verizon in 2000
An original Bell Atlantic Company which Maryland †
An original Bell Atlantic Company which
became Verizon in 2000 Chesapeake & Potomac Telephone Company of Virginia †
became Verizon in 2000
An original Bell Atlantic Company which
An original Bell Atlantic Company which
became Verizon in 2000 Chesapeake & Potomac Telephone Company of West Virginia †
became Verizon in 2000
An original Bell Atlantic Company which †
An original Bell Atlantic Company which
became Verizon in 2000 The Diamond State Telephone Company
became Verizon in 2000
An original Bell Atlantic Company which
An original Bell Atlantic Company which
became Verizon in 2000 The Bell Telephone Company of Pennsylvania
became Verizon in 2000
An original Bell Atlantic Company which
An original Bell Atlantic Company which
became Verizon in 2000 South Central Bell Telephone Company †
became Verizon in 2000
Stayed independent with operations
Stayed independent with operations
amalgamated as Bell South in 1992 Southern Bell Telephone & Telegraph Company †
amalgamated as Bell South in 1992
Stayed independent with operations Bell South †
Stayed independent with operations
amalgamated as Bell South in 1992
amalgamated as Bell South in 1992
Stayed independent with operations
Stayed independent with operations
amalgamated as Bell South in 1992 New Jersey Bell Telephone Company †
amalgamated as Bell South in 1992
An original Bell Atlantic Company which
An original Bell Atlantic Company which
became Verizon in 2000 New England Telephone & Telegraph Company †
became Verizon in 2000
An original NYNEX Company
An original NYNEX Company which became a Bell Atlantic Company in 1997 which became Verizon in 2000
New York Telephone †
An original NYNEX Company
An original NYNEX Company which became a Bell Atlantic Company in 1997, which
became Verizon in 2000
Became a part of SBC in 1997 Pacific Bell †
Nevada Bell †
An original Pacific Telesis Company
Became a part of SBC in 1997 Southwestern Bell Telephone Company †
An original Pacific Telesis Company
Stayed independent The Mountain States Telephone and Telegraph Company †
Stayed independent
Stayed independent till 1990 and operations
Became a part of Qwest in 2000
amalgamated as US West Communications since 1991
Northwestern Bell Telephone Company †
Stayed independent till 1990 and operations
Became a part of Qwest in 2000
amalgamated as US West Communications since 1991
Pacific Northwest Bell Telephone Company †
Stayed independent till 1990 and operations
Became a part of Qwest in 2000
amalgamated as US West Communications since 1991
US West Communications, Inc. †
Combined operations of Mountain States
Became a part of Qwest in 2000
Telephone and Telegraph Company, Northwestern Bell Telephone Company and Pacific Northwest Bell Telephone Company
from 1991 Stayed independent
Cincinnati Bell Telephone Company †
Stayed independent The Southern New England Telephone †
Became a part of SBC in 1998 Company Central Telephone Company of Virginia †
Stayed independent
Stayed as a part of Sprint Contel of New York †
Became a part of Sprint in 1992
Stayed as part of GTE which then became part of Verizon in 2000 Citizens Telecommunications Company Of New
Became a part of GTE in 1990
Stayed independent York Inc. Contel of Texas †
Stayed independent
Stayed as part of GTE which then became part of Verizon in 2000 Contel of Virginia †
Became a part of GTE in 1990
Stayed as part of GTE which then became part of Verizon in 2000 Contel of California Inc. †
Became a part of GTE in 1990
Became a part of GTE in 1990
Stayed as part of GTE which then became part of Verizon in 2000
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Table 1 Continued
This table describes the entire corpus of M&A activity for the population of the local exchange telecommunications companies including change in ownership, merger, or acquisitions
Company names
Status 1988 to 1995
Status 1996 to 2001
GTE California, Inc.
Became a part of Verizon with GTE takeover in 2000 GTE Florida, Inc. † GTE Hawaiian Telephone Company, Inc. †
An original GTE Company
An original GTE Company
Became a part of Verizon with GTE takeover in 2000
Became a part of Verizon with GTE takeover in 2000 Contel of Missouri Inc. †
An original GTE Company
Stayed as part of GTE, which then became part of Verizon in 2000 GTE Midwest Inc.
Became a part of GTE in 1990
Became a part of Verizon with GTE takeover in 2000 GTE North, Inc. †
An original GTE Company
Became a part of Verizon with GTE takeover in 2000 GTE Northwest, Inc. †
An original GTE Company
Became a part of Verizon with GTE takeover in 2000 GTE South, Inc.
An original GTE Company
Became a part of Verizon with GTE takeover in 2000 GTE Southwest, Inc.
An original GTE Company
Became a part of Verizon with GTE takeover in 2000 †
An original GTE Company
Lincoln Telephone & Telegraph Company †
Stayed independent Puerto Rico Telephone Company
Stayed independent
Became a part of Verizon with GTE takeover in 2000 Rochester Telephone Corporation †
An original GTE Company
Stayed independent
Became a part of Global Crossing in 1999 and Citizens
Communications in 2001 Carolina Telephone & Telegraph Company †
Stayed as part of Sprint United Inter-Mountain Telephone Company
Became a part of Sprint in 1991
Stayed as part of Sprint Central Telephone Company of Florida † †
Became a part of Sprint in 1991
Stayed as part of Sprint United Telephone Company of Florida United Telephone Company of Indiana †
Became a part of Sprint in 1992
Stayed as part of Sprint †
Became a part of Sprint in 1991
Stayed as part of Sprint United Telephone Company of Missouri
Became a part of Sprint in 1991
Stayed as part of Sprint United Telephone Company of Ohio † United Telephone Company of Pennsylvania †
Became a part of Sprint in 1991
Became a part of Sprint in 1991
Stayed as part of Sprint
Became a part of Sprint in 1991
Stayed as part of Sprint
† Company details used in the analysis. Some companies’ data were aggregated and then ratios calculated for the years operations were amalgamated.
acquired by Bell Atlantic. Bell Atlantic had also acquired NYNEX, an RHC in its own right, in 1997. The large Bell Atlantic eventually renamed itself Verizon. The motive was to bring together complementary assets and strengths, create scale and scope economies, permit innovations, and accelerate delivery of advanced services. Additionally, a motive was to tackle competition from cable giants such as AT&T.
Several ILECs went through two merger transactions. The Continental ILECS went through two merger transactions. First, they were acquired by GTE. Then, GTE became part of Bell Atlantic. Similarly, the ILECs of GTE and NYNEX went through two merger transactions. The first was when they were acquired by Bell Atlantic. The second was when Bell Atlantic acquired Puerto Rico Telephone Company and then reconsolidated and renamed the whole group, consisting of erstwhile Bell Atlantic, Contel, GTE, NYNEX, and Puerto Rico Telephone Company, as Verizon. Pacific Telesis was first absorbed into SBC. Then Ameritech was absorbed into SBC, and the entire SBC structure recast. The series of second merger transactions took place after 1996. They led to the creation of giant firms within the sector. Any operating company belonging to these giants would be
a formidable competitor in its territory.
Stated Merger Motives
The primary merger motivation was performance enhancement, to be lean so as to meet emerging competitive threats and improve performance. The companies stated that
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Allied to the notion of synergies was the ability for merged firms to combine resources to expand quickly, subject to regulatory approval, say, under Section 271 of the Telecom- munications Act of 1996, and to offer a bundle of products and services to an enhanced customer base. In the SBC and Pacific Telesis merger, bundling of local access and long-distance services could be feasible subject to Section 271 approval. The combined SBC and Pacific Telesis entity could offer this service, and make efficiency gains, as a result, through higher scale and volumes in respective territories (Goldman et al., 2003). The separate skills needed in providing local and intra-LATA long distance services could
be jointly exploited across different territories, to which the firms were restricted, as these would now belong in a common pool of resources in the combined firm. The additional service volumes would permit cost amortization and enhance efficiencies. 13
Likely Merger Impact and Entry Hypothesis
What impact would the mergers have on new firm entry in the specific territories where they occurred? A sector operating characteristic is network effects. These are external economies, as described by Marshall (1890). They have been defined as network externalities and the presence of increasing returns to scale (Besen & Farrell, 1994; Liebowitz & Margolis, 2002). In a network context, ILECs and entrants could benefit from entry due to the additional demand generated by network externalities (Rohlfs, 2005; Shy, 2001).
The opposite can also be true. Network effects are an entry barrier (Werden, 2001). An ILEC, with anti-competitive ideas, by having access to better organizational infra- structure, through approved mergers, would be able to undertake targeted degradation of newly installed competitors’ facilities (Crémer, Rey, & Tirole, 2000). Such possibilities would induce less entry in the face of mergers in contexts where network effects prevailed. The risks of failure would be magnified, creating large sunk costs, via irreversible invest- ments, and the uncertainties of cooperative behavior from ILECs would heighten the risks involved in entry. 14
13. By merging existing cable and telephone facilities, the merged entity could offer a combination of local phone, Internet, long distance, and broadband services far quicker than either of the firms on their own. In the US West and Qwest merger, the combining of US West’s expertise in providing xDSL to the local loop with Qwest’s high-speed, high-capacity network could lead to faster deployment of advanced services and to a larger customer base than US West could have deployed alone, thus strengthening the merged entity’s finances. The benefits of the mergers were likely on the customer base, which could be scaled up, and on research, service, and product development efforts. In the Bell Atlantic and GTE merger, greater scale and advertising possibilities would allow the merged entity to achieve efficiencies needed to develop a national brand. Further, the acquisition of GTE’s customers would provide Bell Atlantic with access to customers outside its territory (Goldman et al., 2003).
14. This behavior by new firms entering the telecommunications industry, and faced with the presence of large incumbents enjoying the benefits of network effects as well as rapid institutional approval of their merger plans, would be consistent with the documented behavior of minority-owned firms where it was established that firm and entrepreneur characteristics were not adequate to explain performance, and other structural and behavioral features may have played a constraining role (Aldrich & Waldinger, 1990; Kollinger & Minniti, 2006; Rasheed, 2004). Such expansion barriers (Shelton, 2005) would act as constraints on the future growth opportunities of the new entrants, which would not desire to fight the “uphill battle” (Shelton, 2010) to make their business models work in relatively difficult economic and institutional terrains.
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In the sector, a considerable amount of infrastructure investment took place by the ILECs in the period (Koski & Majumdar, 2002; Loomis & Swann, 2005). Most of the entrants were facilities-based new infrastructure entrepreneurs, incurring large sunk costs. Therefore, in the presence of incumbents’ mergers, entries of such entrepreneurs would reduce in the territories where these mergers occurred. The hypothesis tested in the analysis is of a negative relationship between incumbent ILECs’ mergers and the entry of new firms in each ILEC’s territory.
Details of Analysis
Method of Evaluation and Data
Longitudinal evaluation has been carried out to assess the dynamic impact of actual ILECs’ mergers on new firm entry in ILECs’ territories. The unit of analysis is the ILEC.
A balanced panel of data for the 41 key ILECs, obtained from the Statistics of Commu- nications Common Carriers (SCCC) for the 14-year period of 1988 to 2001, has been used to conduct the panel data analysis. These data were based on a compilation of firm level operational and financial statistics, for all principal ILECs, for all the years between 1988 and 2001.
For decades, to support regulatory tasks, the FCC has been collecting detailed data on ILECs’ operations in a common format, standardized across all of the regulated firms. Numerous variables can be constructed from such information. Other data sources have been used. These have been the Federal-State Joint Board Monitoring Reports, FCC reports on Competition in the Telecommunications Industry, and National Regulatory Research Institute (NRRI) reports. These data have been used numerous times (e.g., Majumdar, 2011; Majumdar, Moussawi, & Yaylacicegi, 2010) before.
Effectively, the firms evaluated have formed the ILECs’ population. The total firm– year observations in the panel have been 574. For every firm after merger, its performance relative to itself in the past, when it had not been taken over, or relative to other firms in the same period, which had been either not taken over or taken over, can be evaluated in the data panel.
Entry Measure Dependent Variable
The primary dependent variable evaluated is CLECs’ entry. The entry of entrepreneur- ial competitors increased after the introduction of the Telecommunications Act of 1996. The competition data have been collected from the FCC Competition in Telecommunications Industry reports. The variable has measured entry of new entrepreneurial firms (Competi- tion ). It has been calculated as a count variable, and is the number of licensed new entrepreneurial CLECs present in each ILEC’s territory in each time period. Typically, each ILEC’s mandated territory is the state. There are some ILECs with multistate mandates.
This variable represents the intensity of market competition in each state. 15 For a multistate
15. There is no built-in bias that mergers would reduce the number of competitors. Each ILEC that was mandated to operate in a particular territory remained so mandated even after a merger, since local exchange operations were regulated. The merger had the impact of bringing numerous ILECs under a common ownership and a parent holding company. This enabled the parent holding company to leverage its common organizational assets, such as advertizing, branding, research, and marketing capabilities, across numerous operational territories where the owned ILECs operated. The mergers kept the number of existing operating ILECs the same. A merger did not reduce the number of competitors in a locally mandated territory.
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ILEC, the variable has been an average of CLECs across the number of territories each ILEC operated in. 16
Such a count measure, of new entrepreneurial firm entry, captures emergent competitive dynamics. The count measure has been used often in the competitive dynamics, entrepreneurship, industrial organization, and population ecology literatures (Brown & Zimmerman, 2004; Carroll & Hannan, 2000; Frech, 2002; Geroski, 1995; Majumdar, 2011). Since a count measure has been used, it is not possible to identify 17 the specific type of competitor as either a reseller, a lessee of unbundled lines, or as a facility-based entrant. Because, however, a considerable amount of infrastructure invest- ment took place by the ILECs in the period (Koski & Majumdar, 2002), most of
the entrants have been facilities-based new infrastructure investors. 18 Since, however, the analysis of the article deals with a specific phenomenon of mergers and entry at a particular time and context, the geographic specificities for that context have been taken into account.
Figure 1 displays the average values for the Competition variable, computed as an average of the variable for all firms in all territories, over each period of time. Between 1996 and 2001, there was a tapering off of this growth, possibly as the result of the decline of several CLECs’ businesses, as well as industry meltdown. This tapering off could be due to the aggressive anticompetitive behavior of the ILECs (Ferguson, 2004; Koski & Majumdar, 2002) protecting their monopolies. The average number of new entrepreneur- ial firms, present within each territory, in the 1996 to 2001 period was more than four times the average number of such firms, present within each territory, in the 1988 to 1995 time span. Clearly, a major structural change occurred in the sector.
Merger Variables
A dummy variable denotes the occurrence of a merger, and once an ILEC has engaged in a merger act it is thereafter identified as a merged entity for later periods. All the merger acts fully corresponded with a list of mergers maintained at
Conversely, the number of entrants served to enhance the number of possible competitors each ILEC would face, even after a merger.
16. The industry has moved, in the past 15 years, from being a set of local, regulated monopoly firms, with a clear geographic specificity, to a set of geographically diffuse national competitive firms, especially with the emergence of wireless and Internet communications. The data set covers a period when the local, specific competitive landscape was as demarcated in detail as it could be, and the matching of competitors was as relevant as feasible, though with the advent of CLECs, from the mid-1990s, competition began to become geographically diffuse and generalized. Now, of course, two or three wireless companies provide diffuse, generalized competition for other communications providers in the industry.
17. Path dependencies matter in entrepreneurial behavior; however, entrants’ identities were not available. It was not feasible to identify whether past entry in one territory by a specific competitor might lead it to enter other territories at the same time or at later period.
18. Wireless provider inclusion as new entrants is inappropriate, though several of these firms during the time were also entrepreneurial entrants. Wireless providers have provided diffuse and generalized competition, across the nation as a whole, or across much larger geographic boundaries compared to the territories that ILECs have operated in. Today, of course, with industry consolidation, there are just a few oligopolistic firms in the wireless sector. All of these compete nationally. Specific geographic boundaries do not matter to these firms. Similarly, the advent of Internet telephony has made local operating boundaries in the sector almost redundant. In a sense, in less than a generation, the structure of the communications sector has changed from that of localized and regulated monopolies to a generalized competitive landscape, albeit one still regulated in many ways.
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Figure 1 Average Number of Competitors per Territory in Each Period With Growth
Trendline
http://www.cybertelecom.org. Several merger transactions have been studied. The design of dummy variables to control for merger impact is based on prior research on mergers (Gugler & Yurtoglu, 2004; Majumdar et al., 2010). Given the sector’s circumstances, two merger variables have been used: a merger dummy if an ILEC went through a merger transaction once; and a second merger dummy variable in case an ILEC expe- rienced a merger transaction a second time. For example, Pacific Bell and Nevada Bell, part of Pacific Telesis, initially merged with Southwestern Bell, the ILEC of SBC. A few years later, SBC acquired Ameritech; then, the entire ILEC operations, including that of Pacific Bell and Nevada Bell, were consolidated within SBC. Thus, Pacific Bell and Nevada Bell went through two merger transactions.
The way the firms keep records, based on regulatory accounting maintained require- ments to this day, each ILEC has retained its accounting identity set up decades ago. Even if an ILEC has been taken over, by merger, this accounting identity has remained. The data reported for the period 1988 to 2001 are based on these identities. This feature is useful, because it permits clean analysis for a panel consisting of a large cross-section, per period, as well as a long time series. In the cross-section, for any year, the behavior of a non-merged ILEC can be compared with that of a merged ILEC. In the data time series for a particular ILEC, its behavior as a merged firm can be compared relative to its behavior when it was a non-merged ILEC. If the merger variable is used as an explanatory variable, then, within a panel, whether an ILEC has merged or not is clearly
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Dynamic merger analysis has been necessary. Concerns relate to the motivations of entrants, speed of adjustment, interrelationships between the strategic decisions of incumbents to merge and for competitors to enter a market. These concerns can be addressed by introducing merger dummy variables with time lags. To differentiate between immediate and longer mergers’ effects on entrants’ behavior, a time-variant post-merger dummies design (Elsas, 2004; Majumdar et al., 2010) has been used. This research design for merger impact analysis isolates the impact of each time period before mergers as well as that of the contemporaneous period on entry patterns. For the first and second mergers, dummy variables have been constructed for two periods pre- ceding the merger, for the merger period, and for a period after the merger. A period has been a year.
The explanatory variables have been first merger t-2 , first merger t-1 , first merger t0 , and first merger t+1 . Similarly, other variables are second merger t-2 , second merger t-1 , second merger t0 , and second merger t+1 . A 4-year evaluation of merger transactions is feasible with such a design. A two-prior-period design picks up potential new entrepreneurial entrants’ actions from time of announcement to time of consummation. Generally, most merger announcements and consummation take place in a year. In this sector, often 2 or more years have elapsed between announcement and consummation because of the need for regulatory clearances to be obtained. Thus, dummies before the merger transactions evaluate new firm entry in the periods preceding the merger consummation; merger dummies for the merger year evaluate the impact of mergers on entry during the consum- mation year itself; and, merger dummies for the post-merger period evaluate the entry impact of consummated mergers a year later.
Control for the Telecommunications Act of 1996
Comprehensive entry evaluation would necessitate taking into account the influence of many factors (Geroski, 1995). The importance of institutional factors has been high- lighted in the early part of the article. An important such institutional factor in the sector was the passage of the Telecommunications Act of 1996 (Act of 1996). The impact of this legislation would be important in inducing entry in ILECs’ markets, as this industry structure-changing legislation was intended to bring in competition into the sector monopolized by the ILECs. To control for the change in industry structure after 1996,
a dummy control variable was introduced.
Control for Section 271 Effects
So that they could enter into other inter-LATA long distance markets, the 1996 legislation required ILECs to meet requirements under Section 271 of the Telecommuni- cations Act of 1996 (Economides, 1999). Prior work (Brown & Zimmerman, 2004) had found the Section 271 rules as influencing entry positively in jurisdictions where permis- sion had been granted. Based on the data on Section 271 approvals, as given in Brown and