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Journal of European Public Policy 11:1 February 2004: 3956

Transatlantic divergence: GEHoneywell and the EUs merger policy*


Eleanor J. Morgan and Steven McGuire

ABSTRACT This paper analyses the reasons for the severe EUUS disagreement over the proposed merger of two US rms, General Electric and Honeywell, which would have been the largest industrial merger in history. The case, one of the relatively rare instances where the European Commission prohibited a merger, is interesting because the EU and US authorities took opposing decisions even though the merger affected world markets. The paper argues that the Commissions investigation of this complex case was undermined by its relative autonomy, combined with procedures, processes and a lack of resources that left it vulnerable to inadequate analysis. The deal broke down not because of failures in communication between US and EU ofcials, but rather because of the limited and awed assessment by Brussels which the EU system allowed. KEY WORDS Competition policy; EUUS relations; General Electric; Honeywell; Merger Control Regulation; mergers.

1. INTRODUCTION Commercial relations between the European Union (EU) and the United States (US) are characterized by very high levels of interdependence and are conducted, for the most part, perfectly amicably. The US is the EUs most important trading partner, taking almost a quarter of all EU exports worth 230 billion euros in 2000 (European Commission 2003a). Both actors are signicant investors in each others economies as well as the largest foreign investors in third countries, and both the US and the EU have special responsibilities in the international economy thanks to their economic weight. In short, the EU and the US matter economically and so does their bilateral relationship. Given that the relationship is generally harmonious, the cases where the relationship is strained attract attention not only for their novelty, but also because of the gravity of a signicant EUUS split. One area where the occasional split features is competition policy. The EUUS dispute over the EUs ban on the purchase of Honeywell by
Journal of European Public Policy ISSN 1350-1763 print; 1466-4429 online 2004 Taylor & Francis Ltd http://www.tandf.co.uk/journals DOI: 10.1080/1350176042000164299

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General Electric (GE) attracts interest for two main reasons.1 First, it represented an instance of the exercise of extraterritorial competition policy towards two US-based multinational rms on the part of the EU. The controversy surrounding the case is reminiscent of the transatlantic rift in 1997 when the European Commission (the Commission) threatened to block Boeings purchase of McDonnell Douglas (Damro 2001). While the Boeing merger crisis was resolved after considerable diplomatic brinkmanship by modications to the proposal to satisfy the EU, the GE deal was killed by the European authorities amid acrimony that persisted for some time. Second, the EU and US authorities came to diametrically opposed views about the likely effects of the merger even though it affected world markets so there was no difference in the geographic scope of their analyses or the products investigated. This divergence was even more notable in view of the increased efforts to co-operate on merger cases by the US and EU authorities since BoeingMcDonnell Douglas. GEHoneywell was certainly the largest, highest prole and most controversial merger proposal for many years and the fact that divergent decisions resulted, in spite of a myriad of institutional arrangements designed to avoid EUUS conict, presents something of a puzzle. This paper investigates why this transatlantic split could have occurred through a detailed analysis of the merger and the policy context in which the EU decision was taken. It proceeds as follows. Section 2 provides a summary of the merger and its eventual prohibition by the Commission. Section 3 considers some of the possible explanations for the EU decision with particular emphasis on the Competition Directorate as a policy actor. Section 4 provides a detailed investigation of the economic arguments advanced by the Commission and highlights their limitations. Section 5 explores differences in substantive assessment between the US and the EU, particularly as regards conglomerate mergers. The nal section reects on the ndings. 2. THE MERGER A BRIEF HISTORY GE makes a variety of goods from light bulbs to hydro-electric turbines. One of its key operating units is the General Electric Aircraft Engines division based in Cincinnati, Ohio. GEs only effective independent competitors in the supply of civil aircraft engines are Pratt & Whitney, an arm of United Technologies, and Rolls-Royce plc. GEs leading position in civil aircraft grew largely out of its success as a military engine supplier to the US Air Force and it has eroded Pratt & Whitneys once overwhelming market share. GE is also one of the worlds largest lessors of civil aircraft through GE Capital Aviation Services (GECAS). Honeywell is a diversied technology and manufacturing company, established in a variety of markets as a manufacturer of control systems. Its aerospace division had a strong position in ight control systems, the bundle of computers, software and cockpit displays that control the aircraft. As in most

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other aerospace sub-sectors, the number of competitors was small. Honeywell eliminated one competitor in 1998 by purchasing Allied Signal (although this merger had other motives, not simply reducing competition); the only other signicant player in the civil aircraft market was Sextant Avionique of France. In mid-2000, Honeywell essentially put itself up for sale in the wake of disappointing sales gures and paradoxically difculties in integrating Allied Signal. Both United Technologies and GE entered the bidding, but GE eventually emerged victorious with a $US 42 billion bid in October 2000. The deal, if consummated, would have been the largest merger of two industrial groups in history. Jack Welch, the legendary chief executive of GE, delayed his retirement to see the deal through to completion; this was to be the nishing touch to an illustrious career as head of the worlds largest company. In February 2001, the Competition Directorate of the European Commission announced that it would begin a full (phase two) investigation of the merger. This apparently took GE by surprise as the company had anticipated a more timely resolution of the investigation (GE 2001a).2 The main criteria for a merger to fall under the European Merger Control Regulation (MCR) are that the parties should have a combined world-wide turnover in excess of ve billion euros with a combined European turnover of at least 250 million euros. With combined world-wide sales of 180 billion euros and a European turnover of 29 billion euros (GE 23 billion euros and Honeywell six billion euros), there was no doubt about the legitimacy of an EU investigation.3 Both the Commission and the US Justice Department (DoJ) scrutinized the deal through the rst months of 2001 and both regulatory authorities made it clear that some divestitures would be the price GE would pay to gain control of Honeywell. The DoJ ruling in May 2001 was broadly supportive of the merger, asking that the parties sell off Honeywells military helicopter business and agree to authorize a new third-party provider of maintenance, repair and overhaul services for certain of Honeywells aircraft engine and auxiliary power units. GE pronounced itself satised with the agreement (GE 2001b). However, EU authorities were proving tougher to convince and insisted on further divestitures. Only weeks after gaining American regulatory approval, GE executives headed by Jack Welch himself arrived in Brussels to present a set of proposals to save the deal. The offer made by GE included a major divestiture of Honeywells aerospace business, worth $2.2 billion, as well as the transformation of GECAS into a separate though wholly owned operating division which would deal with Honeywells products at arms length. GE accepted that the offer fell short of Commission demands and on 28 June presented a last ditch set of proposals which included the sale of a minority interest in GECAS. These last-minute proposals were rejected by the Commission, not only because of the lack of time for consultation but also because they were not seen as solving the competition problems. On 3 July, the Commission formally issued its decision to block the merger.

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3. DG COMPETITION A BUREAUCRACY UNDER PRESSURE? EUUS relations in competition policy are conducted within a complex and well-developed set of comity provisions. It might be tempting to locate the source of the GEHoneywell conict in the failure of the new comity arrangements agreed by the US and the EU in the wake of the Boeing controversy. The difculty with this argument is that both sides agreed that there had, in fact, been high levels of communication and negotiation between the respective authorities throughout the case. According to the Commissions ofcial report on the operation of its comity agreements with North America in 2001: Although the Commission reached a divergent outcome from that of the US DoJ, this did not result from a lack of transatlantic cooperation. Indeed, cooperation between the Commission and the DoJ was very intense and started early in the process, that is well ahead of the actual notication of the transaction to the Commission. (European Commission 2002a: para 1.2.1) On the American side, Charles James, Assistant Attorney General at the US Antitrust Division of the DoJ, for example, asserted that the outcome of GE Honeywell was not due to a failure of co-operation; in fact it would be hard to imagine how we could have cooperated more closely (James 2001). That the dispute arose in spite of numerous channels designed to provide early warning of potential conicts and to aid in their resolution suggests that the underlying approaches to this case in the two regimes were substantially different. This might be due to transatlantic differences in institutional structures and policy contexts as well as differences in the nature and rigour of substantive assessment. This paper suggests that all played their part and that the explanations are to some extent interrelated. The Competition Directorate is one of the most high prole of the Commissions directorates presiding over one of the most developed and successful policy areas of the EU (McGowan 2000: 116). Its high prole is due to several factors. First, competition policy is, like trade policy, an area where the Commission has strong powers enshrined in the founding European Economic Community (EEC) treaty (see, for example, Smith 1998). Second, the Competition Directorate has gained inuence since, partly thanks to the essential role played by competition policy in catalysing the Single Market Programme. Breaking down barriers to trade within Europe implied an important role for regional enforcement of competition laws and successive competition commissioners capitalized on this to enhance the role and status of the directorate. Third, the increase in merger activity world wide has led to an increase in the number of investigations under the MCR, with notications rising steadily from 1993 and peaking at 345 cases in 2000. The intense merger control activity had already established the Competition Directorate as a major player on the world stage with extraterritorial powers conrmed by

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the European Court (Morgan 2001) so arguments appealing to opportunism by the Commission seeking to build an international identity (as earlier in Damro 2001) seem to lack weight by the time of GEHoneywell. McGowan (2000) observes that the Competition Directorate is a prime example of regulatory policy-making in view of its reliance on law as the basis of power, the relative autonomy of the bureaucracy, and the existence of an epistemic community or network of experts. The Competition Directorate enjoys perhaps the greatest degree of autonomy among the directorates, as neither the European Parliament nor the Council of Ministers has a role to play (McGowan and Cini 1999). Moreover, in stark contrast to its American counterparts, who have to obtain an order from an independent judicial authority before banning a merger, the Competition Directorate combines both investigative and judicial roles. Bureaucrats in the same organization decide which cases to prosecute, provide the analysis as part of the investigation, and are intimately involved in the decision and outcome. This has led to criticisms that the Commissions processes lack transparency and accountability (McGowan 2000:117) and the role of the Commission as chief investigator, prosecutor and judge is something that US rms (and EU ones, for that matter) nd unsettling. Indeed, it was reported that, as the case progressed, GE found that dealing with the members of the task force increasingly seemed like a through-the-looking-glass tumble into an unfamiliar world where processorientated technocrats, answerable to no one, made law and changed the rules as they saw t (Murray et al. 2001). Although the Commission has made much of the fact that it is open to stringent third-party review through the appeals procedure, Court judgments can take a considerable time three years, for example in the Airtours case with the recent fast-track procedures providing only limited improvements. Many rms negotiating with the Commission take the view that it is better to compromise with the Commission (regardless of the merits of the Commissions case) to obtain clearance as a successful appeal is unlikely to enable the merger proposal to be resurrected. However great the autonomy of Commission ofcials, it remains a relative autonomy. Like other bureaucracies, the Competition Directorate has developed formal, ongoing (what Anthony Downs called professional) relations with other stakeholders (Richardson 2001: 102). The competition policymaking process is populated with a wide variety of interested parties ranging from the rms involved in a specic case, to outside lawyers and economists, to member states and, as this case illustrates, foreign anti-trust bureaucracies. Consultations with these stakeholders generate an important output legitimacy to Commission action (Bouwen 2002). The Commission engages with these parties in both formal and informal ways. Formal interaction, such as the notication of investigations or requests for information, sits alongside an informal, negotiated process of bargaining among parties, not least at the point that a remedy is sought. This leads to a policy-making process of considerable complexity, with which bureaucrats must cope.

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How do bureaucracies cope with complexity? Analyses of European public policy formulation quite rightly emphasize the variability of policy-making patterns across a relatively decentralized Commission (Richardson 2001:112). From this perspective complexity yields up a uid environment of negotiations among interest groups and bureaucrats. However, within this uid environment exists a world of routine and stability. Stakeholders do not it in and out of the policy process, nor do bureaucracies produce bespoke solutions for each policy problem. From (2002) provides helpful insights derived from sociological institutionalist literature. This literature examines how complex organizations react to uid, information-rich environments. In a manner akin to individuals, bureaucracies cope with complexity by establishing routines and norms designed to structure and make comprehensible the complex environment (From 2002: 221). In essence, this process is the bureaucratic equivalent of individual satiscing and the effect can be to privilege certain types of information and certain actors (Surel 2000: 500). This is particularly true in instances where the ofcials are over-stretched or lack the requisite expertise. The Competition Directorate seems to offer a prime example of this situation. In 1999, the Directorate had some 150 policy ofcers covering the range of competition policy, from cartels and mergers to state aid (McGowan 2000: 122). It had only fty-six case ofcers to deal with the unprecedented wave of mergers and acquisitions affecting the EU and few professional economists, contrasting with the traditionally relatively well-resourced bureaucracy in the US. Besides the dramatic increase in merger investigations since the MCR was introduced (with 335 EU notications in 2001) there has, more importantly, been an increase in the complexity of the cases, with the number requiring in-depth, phase two investigations rising 100 per cent from 1999 (European Commission 2002b: 18). In its reaction to the 2000 annual report, the European Parliament expressed concern about inadequate stafng levels (European Commission 2001a: 360) and the Commission indicated that it would seek to increase its stafng levels so as to full its obligations effectively. However, the extra staff recruited appear to have been assigned to cartel investigations and not to the merger task force (European Commission 2002b: 4). Brigid Laffan drew attention to the implications of under-resourcing within EU institutions several years ago. She noted that, while the Commissions small size might be an advantage in initiating policy (policy entrepreneurship), it was not an advantage in managing a complex policy environment. She also identied the underdeveloped self-regulatory structures as a weakness in the Commissions ability to manage complex, ongoing policies (Laffan 1997: 427). Page (2001) similarly suggests that the Commissions structure can militate against effective policy implementation. The way the Commission is structured its co-ordinate mode of production is characterized by low levels of hierarchy, lack of technical skills and a resultant reliance on external mechanisms to deliver policy. Any bureaucracy can be vulnerable to regulatory capture, but the Commission, with its large mandate without concomitant resources and lack of robust accountability procedures, may be particularly

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prone. In their assessment of the initial years of the MCRs operation, Neven et al. (1993) drew attention to the apparent vulnerability of the new instrument to political inuence and regulatory capture by various interest groups. These concerns have persisted into the later years, as illustrated by the controversy surrounding BoeingMcDonnell Douglas. This type of under-resourced structure, operating with considerable autonomy within the tight timetables of the MCR (which require a nal decision within ve months of the opening of full proceedings), might be expected to lay itself open to the possibility of excessive reliance on the views of interested parties and decisions based on inadequate analysis. One of the procedural differences between the US and EU merger controls highlighted by Devuyst (2001) and Venit and Kolasky (2000) is the Commissions tendency to take far greater account of competitor submissions and arguments than the US authorities. This may not just be because of the difference in the institutional structures and procedures arguably, it may also partly be because in the fragmented EU market, which is still restructuring following liberalization initiatives, the consequences of mergers for competitors are naturally of more concern. According to Sauter (1999: 52), the EU does not make a strict distinction between industrial policy focused on market structure and competition policy to protect the process of competition. The signicant discretionary powers of the Commission under the MCR allow some role for industrial policy considerations to feature implicitly in the nal outcome and these might be expected to be particularly marked in a strategic industry like aerospace. However, it is notable that merger decisions in other industries, where industrial policy issues are less obvious, have also relied heavily on competitor submissions and suffered from inadequate analysis. Increasing public criticism about the quality of the economic analysis underpinning some of the recent EU decisions has been sharpened by three Court judgments in late 2002 where, for the rst time, Commission vetoes on merger deals were overturned. In the appeal resulting from the ban on AirtoursFirst Choice,4 a merger of two UK rms affecting the package holiday market, the Court of First Instance concluded that the decision was vitiated by a series of errors of assessment. Similar rebukes were contained in the judgment on the SchneiderLegrand appeal following the ban on a merger between two French electricity companies.5 The decision on Tetra LavalSidel, which affected the packaging market, was judged to be vitiated by manifest errors of assessment and the merger (between the French rm, Sidel, and the French subsidiary of a Dutch rm) was the rst to be consummated following a successful appeal against an EU ban. This added a further blow to the Commissions standing.6 The effect of these recent rulings has been to call into question the operating procedures employed by the Commission that allowed awed results to emerge.7 4. THE EUS INVESTIGATION: AN INAPPROPRIATE TOOLKIT? Each merger satisfying the turnover thresholds of the MCR is appraised in terms of its likely effects on competition in the EU. According to Article 2(3)

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of the MCR, a merger which creates or strengthens a dominant position as a result of which effective competition would be signicantly impeded is unacceptable.8 The MCR includes a fairly unsystematic list of factors to take into account in the assessment of dominance and there are no formal guidelines. This relatively loosely drawn set of criteria allowed the European investigators considerable discretion in their consideration of the merger. The proposed merger would have combined the parties complementary offerings and strengths within the aerospace industry and conglomerate effects appear to be at the heart of the EUs objections to the deal. These initially centred on concerns about the anti-competitive effects of discounts on packages of products (bundling) by the merged rm. The nal decision, however, stressed that access to GEs nancial resources and its vertical integration into aircraft purchasing, nancing and leasing would strengthen Honeywells already leading position in various markets by introducing the possibility of crosssubsidization and predatory behaviour. In both cases, the Commission foresaw rivals leaving the industry as a result of the merger, further enhancing the position of the merged rm. The Commissions concerns about bundling received most attention in its published decision. GE already offered the possibility of buying nancial and maintenance packages with its engines. The Commission judged that the broader product range of the merged entity would allow it to extend this bundling strategy and offer various types of packages of engines and avionics components at attractive prices. According to the nal decision, the merged entity will be able to offer a package of products that has never been put together on the market prior to the merger and that cannot be challenged by any other competitor on its own (GEHoneywell decision 2001: para. 350). The Commission concluded that such bundling would harm competition in the longer term; competitors would nd it difcult to match these offerings and could be forced to exit the business. There are a number of unusual and questionable aspects in this analysis, as discussed below. In particular, the view that the discounting associated with bundling would harm competition was a new departure in the Commissions merger analysis. Previous decisions on conglomerate mergers had not centred on the effects on pricing strategies.9 In addition, the conventional concern of merger policy is that mergers will lead to higher prices as the result of increased market power. In contrast, the issue in GEHoneywell was about prices being reduced, at least to start with, as a result of the merger. Part of the explanation of this puzzle lies in the relationship between Commission ofcials and the rms involved, particularly the reliance by the Commissions investigators on one of GEs competitors. The Commissions initial objections to the deal were based on a model developed by Jay Choi, adviser to Rolls-Royce, one of the parties opposing the deal (see Choi 2001 for the public version). This investigated the likely effects of mixed bundling, which is dened as offering packages of products at discounted prices in addition to selling the various elements individually. The model was developed

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from earlier work by Barry Nalebuff who had shown the scope for enhancing market power by pure bundling selling products only as part of discounted packages, and not individually (Nalebuff 2000). Choi concluded from his own model of the mixed bundling case that the effects of package discounting would lead to rivals eventually leaving the affected markets. Nalebuff assessed Chois stylized model on behalf of the parties to the merger (a published version of his critique appears in Nalebuff 2002). He concluded that the model was not applicable to aerospace markets, characterized as they are by extensive product differentiation, strong buyers and individually negotiated purchases. Further, he found that when a model is constructed to reect the competitive realities of the industry, product bundling would not actually be advantageous. As Nalebuff (2002) pointed out, if bundling was a successful strategy in aerospace markets, as the Commission suggested, rivals would be likely to collaborate so they could offer bundles to compete with GEHoneywell. After consultation with some of its customers, GE offered not to engage in this type of discounting after the merger to try to remove the competitive concerns and reach a settlement (Trimble 2001). This, in itself, suggests that the merger proposal was not driven by any enhanced possibilities for mixed bundle pricing across the products of the merged rm. The Commission dislikes remedies concerned with future behaviour as these can be difcult to monitor and enforce (European Commission 2001b; Morgan 2002). This behavioural remedy would have been relatively easy to administer (compared with those accepted in BoeingMcDonnell Douglas, for example) as it only required the component elements of the rms bids to be itemized and add up to the total for the package. Yet the proposal was rejected. In its nal decision, the Commission asserted that the likelihood of bundling was a reason to prohibit the merger, although it conceded that its concerns about the effects of bundling were not based on a particular economic model: The various economic analyses have been subject to theoretical controversy, in particular as far as the economic model of mixed bundling, prepared by one of the third parties, is concerned. However, the Commission does not consider the reliance on one or the other model necessary for the conclusion that the packaged deals that the merged entity will be in a position to offer will foreclose competitors from the engines and avionics/non-avionics markets. (GEHoneywell decision 2001: para. 352) With the conglomerate bundling theory under attack, if not completely discredited, attention apparently shifted to the effects of the nancial power of GE and its vertical integration into aircraft purchasing, nancing and leasing to justify the conclusion that the merger would be anti-competitive. Indeed, in subsequent commentary on the case, the Commission has downplayed its reliance on pure conglomerate effects in the decision (see Giotakos el al. 2001;

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Drauz 2001). For example, Drauz, the Director of the Merger Task Force, claimed in an attempt to set the record straight that: while there is no doubt about the conglomerate nature of the case . . . the effects identied by the Commission rest more with the implementation and transfer of GEs toolkit for dominance to Honeywells products rather than with genuine portfolio effects. (Drauz 2001: 192) It is questionable whether GE did enjoy a dominant position in the market for large jet engines. The Commission reached this conclusion because GE had recently won more orders for engines than competitors, often by aggressive bidding. It could be argued, however, that if GE was dominant, it would not have needed heavy discounts to win orders from rivals and that current sales in bidding markets are not necessarily a guide to future shares; this was the approach taken in the US. In addition, if the objections to the deal were really based on the transfer of power to Honeywell, it is not clear why the Commission found that the merger would strengthen GEs position in large jet engines which it judged already dominant. This result seems to depend on the existence of bundling effects. The Commission claimed that the crucial tools in GEs so-called toolkit for dominance were its nancial strength, enhanced by its nancing arm, GE Capital, and its vertical integration through GECAS into aircraft purchasing. The analysis of these factors, which the Commission expected would allow Honeywell to create a dominant position in small corporate jet engines, and in its avionics and non-avionics markets, often appears highly speculative. GE Capital is a major nancial organization which would rank in the top twenty of the USAs largest corporations if it were an independent company. The Commission noted that In addition to having enormous nancial means available in-house, GEs unmatchable balance sheet size offers other major advantages to GE businesses (GEHoneywell decision 2001: para. 108). In particular, the strong nancial position of GE was seen as allowing it to take more technological risks with its R&D than competitors, to obtain exclusivity deals by giving nancial support to airframe manufacturers and to sell engines at substantial discounts, increasing the nancing requirements of competitors introducing new engines. According to the nal decision: These heavy discounting practices actually resulted in moving the breakeven point of an engine project further away from the commercial launch of a platform. Given its enormous balance sheet, GE has been in a position to increase rivals funding cost by delaying the inception of cash ows and consequently increasing the need to resort to external nancial means. (GEHoneywell decision 2001: para. 111) The Commissions concern that the nancial power of GE would lead to anticompetitive effects appears hard to defend. GE is a diversied company and aerospace projects would have to compete with projects in other areas for

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funds within its internal capital market. Rivals with less access to funding inhouse should be able to attract funds from the capital market for product development projects unless they were viewed as having a poor record for assessing their likely technological success. There is, however, no evidence in the decision to show that rivals in GEs markets were having difculty in raising nance or were investing any less heavily in developing the next generation of engines. Indeed, Rolls-Royce remains a erce competitor in all the segments of the aircraft engine market where GE is active. The second crucial tool in GEs toolkit for dominance, in the Commissions view, was its vertical integration into aircraft purchasing, nancing and leasing through GECAS. GECAS is described as the worlds largest aircraft purchaser, with about 10 per cent of aircraft purchases, and only leases aircraft powered by GE engines. According to the Commission, GECAS has an impact on the engine market far beyond its market share and this could be extended, through a multiplier effect, to strengthen Honeywells position in the avionics market. It was claimed that GECAS inuenced the selection of engines in GEs favour both by seeding smaller airlines with aircraft powered by GE engines, which led them to standardize their future eets on this type of aircraft, and by acting as a launch customer. The effects of GECAS as a launch customer were seen as being reinforced by GEs nancial strength, allowing incentives to be offered to airframe manufacturers to obtain exclusivity deals. A number of aspects of this line of reasoning are, at best, unclear. The concern about the effect of GECAS leasing activities is essentially about tying that competitors could potentially be foreclosed by GECAS tying GEs engines (the tied product) to its leasing activities (the tying market). Normally for tying to result in foreclosure there must be dominance in the tying market but GECAS did not have a monopoly position of this type. It is therefore not clear how GECAS would be able to ensure that aircraft customers would have to take aircraft with GE engines if these were not their preferred choice as they could nance their choice of equipment through other lessors. Rival leasing companies might be expected to differentiate themselves from GECAS by offering non-GE engines to customer requirements. GEs ability to seed airlines with GE engines would depend on the importance, in practice, of the standardization of eets and the evidence provided in the decision leaves room for debate both about this and about the actual signicance of GE as a launch customer. The Commission acknowledged the existence of mixed eets for the same type of aircraft but argued that this does not necessarily show the irrelevance of the commonality benets (GE Honeywell decision 2001: para 158). No convincing evidence is given as to why rivals could not counter GECAS seeding policy by offering discounts to encourage potential buyers to adopt their products. The Commission claimed that the impact of GECAS on the engine market could be extended through a multiplier effect into avionics, so helping Honeywell to a position of dominance. The basis of these multiplier effects in avionics was not explored in any detail in the decision. Similarly, the possibility

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that tying GECAS leasing services to avionics might adversely affect GEs engine activities was not discussed. It is tempting to dismiss the importance of GECAS; certainly the effects of GEs integration into leasing have attracted relatively little interest compared to the bundling issue in the debates since the decision. In contrast to the welldeveloped literature on bundling, the effects of partial vertical integration in activities where technological development is an important aspect of competition have been little explored. It is interesting to note, however, that when GE was trying to negotiate remedies with the Commission, a structural remedy whereby GE would lose control of GECAS was not acceptable to GE, suggesting that it was regarded as a signicant source of competitive advantage. In this case, it is arguable that the Commission was more concerned to protect EU competitors than competition. Competitors would clearly not relish the prospect of competing against the enlarged group with the enhanced opportunity to offer discounted prices and favourable packages that the Commission regarded as only achievable through merger. However, the possible adverse effects on competitors would only harm competition if rivals were forced to stop competing in these product areas and were unable to re-enter the market if prices rose later. No evidence was provided in the decision to show that they would be forced to withdraw from these activities, how long this would take and, if they did exit, that they would be unable to re-establish themselves in the market. Indeed, there appear to be signicant barriers to exit from the market. These include the substantial unrecoverable costs incurred by all the major rms in developing their existing activities and their longterm commitments to supplying products which had been certied for use on existing platforms. The effects on rivals remain speculative but, according to the Commissions analysis, customers of the enlarged group would have beneted, at least initially, from the innovative and attractively priced offerings. There was no discussion in the decision of whether the benets to consumers of these lower prices would offset the discounted costs of higher prices that might prevail eventually if rivals left the market. However, it is notable that Boeing and Airbus, the major aerospace manufacturers, did not oppose the deal although this might have been expected if their long-term interests and those of their customers were threatened. 5. DIFFERENCES IN EU AND US APPRAISAL Why was this merger, which involved the analysis of exactly the same product and geographical markets, viewed so differently by the EU and US authorities? The divergence over GEHoneywell appears to have arisen from contrasting approaches to the likely effects of large conglomerate mergers in the two regimes owing to differences in the theories used and in the interpretations of the evidence within the legal standards rather than from differences in the substantive tests themselves.

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The US authorities use a substantial lessening of competition test to appraise mergers, dened as creating or enhancing market power; this is not dissimilar to the EUs yardstick whether a dominant position would be created or strengthened that would signicantly impede effective competition. There is a more signicant difference between the two regimes in the formal role of efciency arguments. US merger guidelines allow an efciency defence in merger cases, although this is rarely explicitly used, whereas the MCR expressly excludes any trade-off between efciency gains and anti-competitive effects. In so far as GE did have favourable access to funding, enhancing its ability to absorb the costs of product failure and to offer discounts and nancial assistance to customers, the merger would be likely to encourage innovation in Honeywells products and result in lower prices. Instead of welcoming this potential source of efciency as pro-competitive, the Commission treated it as anti-competitive. This was not the rst time that increases in efciency had apparently been seen as akin to an efciency offence under the MCR, harking back to the discredited US policy of the 1960s. As Venit and Kolasky, among others, had previously noted, the Commission had come close to suggesting that the possibility that a merger may make a rm with a leading position more efcient is itself a reason for challenging the transaction (Venit and Kolasky 2000: 85; emphasis added). In the run-up to the GEHoneywell decision, increasing attention had been given by the Commission to the possible anti-competitive effects of conglomerate mergers. This growing focus on various indirect effects of such mergers was already being seen by critics as unpredictable, lacking in economic logic, and based on speculation about future behaviour with little attempt to investigate its likelihood (see, for example, Baker and Ridyard 1999; Lexecon 2000). GEHoneywell gave a new prominence to these concerns by bringing the EU and the US head to head in assessing a large conglomerate deal. The US has been sceptical of theories of competitive harm from conglomerate mergers for some time (as explained by the US Department of Justice in OECD 2002). The arguments on which it was claimed the EUs GE Honeywell decision relied that the merged parties would enjoy economies which competitors could not match or that greater size and nancial resources would give the post-merger rm a decisive advantage over rivals are similar to the earlier US doctrine of entrenchment. This was excluded as a reason for prohibiting mergers in their 1982 merger guidelines. Such arguments were, therefore, less likely to cause concern in Washington than Brussels, even if supported by the evidence. Far from strengthening the standing of EU policy, this high prole case has exposed its weaknesses. Since the GEHoneywell ban, the grounds on which it was based have been heavily criticized not only by senior ofcials in the US anti-trust agencies but also by economists, lawyers and other commentators on both sides of the Atlantic (see, for example, James 2001; Nalebuff 2002; Panz and Caffarra 2002; Varian 2001; Wilke 2001). This brings us back to

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the question of how the system of merger control in the EU could allow the merger to be banned unilaterally on the basis of, at best, dubious economic theorizing, questionable interpretations of current realities and speculations about future behaviour which were less than fully explored. 6. CONCLUSIONS This paper has focused on one case to allow a detailed account of an important public policy issue. Eisenhardt (1989: 537) suggests that case research ought to focus on extreme cases where the process of interest is transparently observable . GEHoneywell meets these criteria relatively well. It was a signicant merger both because of the sheer size of the proposed transaction and the transatlantic differences it provoked, which were thrown into sharp relief by the divergent decisions involving exactly the same geographical and product markets. The investigation of the merger was accompanied by particularly intensive media briengs and coverage, giving a window on events as they unfolded, and the EU decision is detailed, running to 130 pages. Case research is particularly valuable in instances where process is important in understanding complex events (Silverman 2000: 104). As discussed, the outcomes of a series of other recent merger cases have similarly suggested that the Directorates processes allow decision-making that is vulnerable to error. A close analysis of GEHoneywell therefore sheds light not just on the case itself, but also assists in understanding how other heavily criticized decisions may have arisen. The transatlantic divergence which marked the GEHoneywell case appears to result from a complex interplay between the different institutional settings and procedures within which decisions are arrived at in the EU and the US, and some underlying philosophical differences about the appropriate scope of anti-trust policy, specically as regards large, conglomerate mergers. The former appears to have been more important. The use of conglomerate arguments in the EU has since been severely restricted by the October 2002 Court judgment on Tetra LavalSidel. Even allowing some scope for these, however, the divergence in the GEHoneywell decision seems to have been driven by inadequacies in the economic analysis that the EU system of decision-making allowed. Following the furore over GEHoneywell, the Commission put both a possible move to a substantial lessening of competition test and the inclusion of an efciency defence on the discussion agenda in its December 2001 Green Paper reviewing the MCR (European Commission 2001c). The apparent willingness to consider adopting the US appraisal criteria signalled the Commissions eagerness to be seen as open to moves bringing a greater convergence of approach in the turbulent wake of GEHoneywell. This is despite the fact that the divergent decisions were apparently not because of differences in the wording of the substantive tests. A willingness to try to overcome transatlantic difculties in merger control is also apparent in the issue of best practice guidelines on

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co-operation in merger investigations by the EU and US authorities (USEU Working Group 2002).10 They are intended to facilitate further co-operation in cases that straddle the Atlantic, even though both sides agree that the divergent GEHoneywell decisions did not arise from failures in this regard. An under-resourced bureaucracy working to tight time scales and with a high level of autonomy can clearly face problems in trying to arrive at consistently well-judged decisions and in being seen to do so. The controversy over GEHoneywell, which occurred as the December 2001 Green Paper was being drafted, together with the three subsequent high prole Court judgments against the Commission in late 2002, were a wake-up call to the Commission to nd ways of increasing the rigour of its economic analysis and enhancing the degree of transparency and accountability in its handling of EU mergers. Following consultation on the Green Paper, the proposals for reform of the MCR (which were published while this paper was under review) dismiss the need to alter the wording of the substantive test, including the role of efciency considerations (European Commission 2003b). Instead, draft guidelines have been published on the appraisal of horizontal mergers; guidelines on conglomerate mergers are promised which it is hoped will clarify the Commissions approach in this contentious area. The main proposed legislative changes to the treatment of mergers investigated under the MCR are to procedure, particularly to timing. These aim to reduce the time squeezes in complex cases to allow more thorough investigation and to give more time for remedies to be considered. A series of non-legislative measures are also promised which are designed to increase the opportunities for merging companies views to be taken into account throughout the investigations, ensuring that they have timely access to both the le and thirdparty submissions, and to improve the quality of the Commissions decisionmaking. In particular, the proposed appointment of a Chief Competition Economist to provide an independent economic viewpoint, assisted by a group of professional economists to be seconded to case teams, seems a promising and much needed move towards increasing the rigour of the underlying economic analyses. The proposed adoption of peer review panels to scrutinize the investigating teams conclusions should provide a potentially useful check at key points in the investigations. While the proposals to change some of the checks and balances within the EUs system of merger control are welcome, they do not address the fundamental question of the Commissions combined role of judge, jury, prosecutor and the relatively slow judicial review process to which it is still subject.11 This institutional framework may be difcult to alter but it has been criticized since the MCR was rst adopted and, following GEHoneywell, has become much more controversial. It will take time to see whether the results of the current proposals for reform, including the increased emphasis on obtaining appropriate economic expertise, are enough to restore the Commissions credibility, or whether more far-reaching changes to the EUs administrative system of merger control will be necessary in future.

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Addresses for correspondence: Eleanor J. Morgan, School of Management, University of Bath, Bath BA2 7AY, UK. Tel: 01225 385004. Fax: 01225 386473. email: mnsejm@bath.ac.uk/Steven McGuire, School of Management, University of Bath, Bath BA2 7AY, UK. Tel: 01225 383765. Fax: 01225 386473. email: mnssmm@bath.ac.uk NOTES
* The authors are grateful to Chad Damro, Georgine Kryda and Michael Smith for comments on earlier versions of the paper. The European Research Institute at the University of Bath provided nancial support. The paper was presented in the competitive track of the Academy of International Business (UK Chapter), 30th annual conference, April 2003. 1 General ElectricHoneywell, Case M. 2220, decision of 03/07/01 (GEHoneywell decision). 2 The speed with which GE agreed the merger, and the lack of appreciation of the possible legal obstacles, have been implicated in the deals failure. We are grateful to Chad Damro for this point. 3 The Commission has always claimed jurisdiction under the MCR on mergers meeting these criteria even if they involve non-EU enterprises or occur outside the EU. BoeingMcDonnell Douglas highlighted the potential problems of extracting remedies when no manufacturing facilities or other assets are based in the EU. The extraterritorial reach of the regulation was conrmed by the March 1999 Court judgment following the appeal by Gencor against the Commissions ban on GencorLonrho, a merger of non-EU parties with South African mining interests. 4 AirtoursFirst Choice, Case M.1524, decision of 22/09/99 and Case T-342/99, Airtours v. Commission, Judgment of the Court of First Instance, 06/06/02. 5 SchneiderLegrand, Case M. 2282, decision of 10/10/01 and Cases T-310/01 and T-77/02, Schneider Electric v. Commission, Judgments of the Court of First Instance, 22/10/02. 6 Tetra LavalSidel, Case M. 2416, decision of 30/10/01 and Case T-5/02, Tetra Laval v. Commission, Judgment of the Court of First Instance, 25/10/02. 7 General Electrics appeal to the Court of First Instance is still pending at the time of writing. 8 Under the European Economic Area agreement of 05/02/92, the Commission takes the position in European Free Trade Association members into account, as well as the EU, in assessing compatibility. 9 See, for example, Coca ColaAmalgamated Beverages and GuinnessGrand Metropolitan, where the concern was about effects on distribution rather than pricing. 10 These focus mainly on synchronizing the timetables as much as possible and also include suggestions on procedure and personnel. 11 A fast-track procedure has been introduced, as mentioned earlier, but this is not granted automatically, is inappropriate for complex cases and still takes too long to keep most deals alive. The Commission has indicated that it is considering further improvements to the judicial review process to allow speedier decisions. This seems a key and relatively unproblematic area of reform.

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