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Matt Levine Thinks Badly About Incentives and Economics

Matt Levine writes (bold added, links omitted):

AT&T’s acquisition of Time Warner is a vertical merger: AT&T mostly owns pipes (DirectTV, cellular networks) that bring content to consumers, while Time Warner mostly owns studios (Time Warner) and networks (HBO, the Turner networks) that produce and package that content. By combining the two, they can achieve some efficiency benefits that should work to lower prices for consumers. For instance, by combining AT&T’s data on its wireless customers with Time Warner’s advertising inventory, they can introduce more targeted ads, which “will lead to higher ad revenues that will alleviate pressure on the programing side and lower the price of video distribution to consumers,” according to Judge Leon’s opinion. In modern antitrust law, more targeted advertising is a consumer benefit. There are those who think that modern antitrust law is bad.

Against these benefits, the government argued that the combined company would have so much market power that it would actually be able to raise prices. This is an unusual argument in a vertical merger—and vertical mergers are rarely challenged—because the merger won’t make AT&T any bigger in any of the businesses it (or Time Warner) is already in. Instead, the government’s theory is that AT&T can use its Time Warner content to bully competing distributors (other cable companies, video-on-demand companies, etc.). Right now, Time Warner makes its money by signing big high-stakes deals with content distributors who want to carry its content. If they don’t reach a deal, then everyone loses: Time Warner doesn’t get paid, and the distributor’s customers get mad that they can’t watch HBO and start thinking about switching cable companies. And so in practice they generally work out a deal; long-term blackouts are very rare.

But once AT&T owns Time Warner, the government argued, its incentives will shift: If it fails to reach a deal with Comcast or whoever, then it still won’t get paid for Time Warner’s content, and Comcast’s subscribers will still get mad and think about switching providers, but now they might switch to AT&T. (To DirecTV, or to some AT&T wireless video product, etc.) Blacking out Time Warner’s networks on a competing distributor will now be good for AT&T’s distribution business, which will give Time Warner more leverage to demand higher prices for its content in those negotiations with distributors. Or that is the government’s theory, which it argued based on some intemperate public statements from AT&T, some worries from its competitors, and the expert testimony of antitrust economist Carl Shapiro.

Judge Leon didn’t buy it. He noted that an AT&T expert witness looked at previous content/distribution vertical mergers and found that “There’s absolutely no statistical basis to support the government’s claim that vertical integration in this industry leads to higher content prices.” And he noted that, even after the merger, it will be in AT&T/Time Warner’s interest to distribute Time Warner’s content as broadly as possible, so it won’t really have that much leverage to demand higher prices:

Indeed the evidence showed that there has never been, and is likely never going to be, an actual long-term blackout of Turner content. Numerous witnesses explained, and Professor Shapiro acknowledged, that a long-term blackout of Turner content, even post-merger, would cause Turner to lose more in affiliate fee and advertising revenues than the merged entity would gain. Given that, there is insufficient evidentiary basis to support Professor Shapiro’s contention that a post-merger Turner would, or even could, drive up prices by threatening distributors with long-term blackouts.

The discussion gets into some odd theory-of-the-firm moments. Several of AT&T’s witnesses were people who had negotiated these content deals at other vertically integrated cable/content companies: “Madison Bond, who has served as a lead negotiator for NBCU during the past seven years when the company has been vertically integrated with Comcast,” for instance, and several Time Warner executives who “testified similarly about their time at the company when it was vertically integrated with Time Warner Cable.” All of these witnesses said the same thing: They never used their ownership by a distributor as leverage in negotiation with other distributors.

When questioned by defense counsel about his prior negotiations on behalf of NBCU, Bond testified that he “never once took into account the interest of Comcast cable in trying to negotiate a carriage agreement.” Consideration of potential Comcast gains during an NBCU blackout “doesn’t factor at all” into his negotations, Bond continued, nor has anyone from Comcast “ever asked” him “to think about that.” Bond’s statements were similar to testimony given by Comcast’s chief negotiator, Greg Rigdon, who testified that he has never suggested, or seen a Comcast document suggesting, that NBC “should go dark on one of [Comcast’s] competitors because then [Comcast] might pick up some subscribers” or that NBCU should “hold out for a little bit more in affiliate fees because that will harm” Comcast’s competitors.

(Citations omitted.) Similarly, a Turner executive said, “I’ve been in Turner when we were a vertically integrated company and had a sister company called Time Warner Cable. And I can tell you that at no time during my tenure there did anyone ask me to consider in my negotiations and how I dealt with other distributors the outcome and impact at Time Warner Cable.”

So basically everyone with experience of negotiating these deals, who had the leverage that the government claims AT&T/Time Warner will have, said: Nah, it never even occurred to us to do that. But the government’s economist testified that of course they would have that leverage and use it. “Indeed, this opinion by Professor Shapiro runs contrary to all of the real-world testimony during the trial from those who have actually negotiated on behalf of vertically integrated companies,” wrote Judge Leon. So he asked Shapiro about it, and got this fun answer:

No, I am aware of that testimony. And so I think there’s a very serious tension between that testimony and the working assumption for antitrust economists that Professor Carlton and I share; that the company after the merger will be run to maximize their joint profits.

Isn’t that sort of lovely? An economist testified about how companies should operate. Actual operators testified about how the companies do operate. The answers were different. “There's a very serious tension,” said the economist. It is really all you could ask for in an antitrust trial: An economic theory of corporate behavior was proposed, it was confronted with the practical reality of the people actually doing the corporate behavior, and the economic theory shrugged and melted away.

Judge Leon is surely right that the tension isn’t as serious as Shapiro thinks:

That profit-maximization premise is not inconsistent, however, with the witness testimony that the identity of a programmer’s owner has not affected affiliate negotiations in real-world instances of vertical integration. Rather, as those witnesses indicated, vertically integrated corporations have previously determined that the best way to increase company wide profits is for the programming and distribution components to separately maximize their respective revenues. … In the case of programmers, that means pursuing deals “to be on all the platforms,” rather than undertaking a “series of risks” to threaten a long-term blackout.

Part of how you combine different businesses is by getting them to work together: If Time Warner is good at selling ads, and AT&T is good at mining customer data, then you smush them together so that AT&T/Time Warner will be good at selling ads based on customer data-mining, which is where the money is. But part of how you combine different businesses is by leaving them to work separately: If Time Warner’s business model is selling programming to every distributor, then changing that model so that it only sells to AT&T, just because AT&T bought it, would be a mistake. Which is which—when you should combine businesses, and when you should leave them to make their own profit-maximizing decisions—is a complicated question, and you can certainly try to answer it with game theory and economic modeling. But sometimes you can just ask companies what they actually do! It is not perfect evidence of what they should do. But it’s pretty good evidence of what they will do.

I've read lots of Money Stuff columns. I often like them. This is the worst one I've seen. People lie. People fail to introspect, especially when the results would be inconvenient.

Of course merged companies work to make an overall profit for the new, single company. Not perfectly, but there's major incentives in companies to make a profit, and these incentives do play a major role in behavior. Sure it happens that sometimes the right hand of the company doesn't talk to the left hand, and they consequently fail to maximize profits. And sure it happens that sometimes the amount of profit available from a particular optimization is too small for the coordination effort required to get it. And sure it happens that people fail to notice opportunities. None of those mean economic theory is wrong.

Why is Levine so naively credulous of some people saying things in court that they have a strong incentive to say? AT&T wouldn't have brought in someone to testify if they were going to say something else that hurt AT&T... And people saying something else would be at risk of getting themselves fired, and maybe other bad things, because they'd basically be saying they personally, and their company, was doing bad stuff that there are various laws against (anti-trust if nothing else – yes anti-trust law is extremely vague, but this seems like the kinda stuff people think that violates it, which is exactly why it was a topic of discussion in this anti-trust case).

Also the witnesses said they didn't go up to Comcast, or whoever, and say "yo, give us lots of money or we'll do a blackout cuz we don't give a damn cuz we own DirectTV" or an equivalent of that. Choosing not to use it as an aggressive talking point, and saying with full clarity what one means, is perfectly compatible with negotiating harder due to the incentives that exist. The testimony also uses careful language, e.g. a person says he didn't suggest doing it, and didn't read any documents suggesting he do it. Another guy says he wasn't asked to take something into account. There's a comment about going dark, which is different thing than using it as a background possibility to negotiate a better deal (which is what they always do, all the time, obviously – of course, if they aren't paid enough money, they will go dark, and everyone on both sides knows it).

Why doesn't Levine consider the incentives people have, and just believes them when they say they act contrary to financial incentives?

And the mathy arguments used are nonsense. Blackouts are too expensive to threaten? Umm, not exactly. Blackouts are always an implied threat in negotiations. If you don't pay us, we will not let you air our shows. Duh. After the merger, the overall cost of a blackout will be smaller for the new merged company than it was for the old company (because e.g. the blackout it benefits DirecTV, which makes up for a portion of the downside).

If no deal is $100 less bad for you than before, you negotiate harder than before and you maybe get a $50 better deal. Even if the deal is worth a million dollars, this is still true, though in that case it'd be too small a factor to worry about. But the argument wasn't "we calculated how big a factor this is, and it's too small to matter much". They didn't figure out what size factor it is. They just denied it's a factor. That's stupid and incompetent, and Levine ought to have noticed if he were competent.

Similarly, the arguments about the benefits of letting different divisions of a company operate independently effect the degree of the issue. Maybe those benefits are larger than the ability of the merged company to negotiate harder and raise prices for TV content. Maybe a lot larger, so the merged company will only pursue the much larger benefit and not concern itself with the smaller benefit that isn't fully compatible with the larger benefit. But Levine doesn't treat it like competing factors and compare their size. He uses one to try to dismiss and ignore the other. That's nonsense. Nor does Levine consider what potential future changes to the company (e.g. some reorganization, selling some other divisions off and getting smaller, whatever) might change the calculations and therefore result in the price raising behavior being economically efficient.

Also, when deciding to believe the businessmen who said "oh no, we would never act according to financial incentives – in fact, we don't even know those financial incentives exist", Levine ignored that there were also public statements by AT&T that admitted it (at least Levine himself said those statements exist, but he didn't quote any or give a source).

Is it true that the best way to maximize profits for a company is for individual divisions to maximize profits? No. You might run your company that way because doing things more optimally is too hard. But that's not the theoretical best way.

And no, Levine, no one said anything about changing the model to only sell the TV shows to AT&T. That's an especially dishonest thing to write.

To be clear: anti-trust laws are evil (which is another thing Levine is clueless about). I'm not saying that mergers should be blocked because prices for some things would be raised, nor am I claiming they actually will be raised. I'm just analyzing the quality of the arguments and thinking presented by Levine, and the big mistakes in the article are on the pro-merger side.

Elliot Temple on July 30, 2018

Messages (3)

Reading the article and remembering things it said and then connecting them to my comments afterward is *too hard for people*. And they won't scroll back and forth to reread things and figure it out – even though that would be a step towards developing the skill of being a competent reader and thinker (it'd be *practice* towards getting better at activities like relating commentary to a passage).

I added bold text mostly on what I comment on later to make it easier, but that isn't enough. I could have done my commentary intermixed with quotes, as I often do, but for various reasons I didn't write it that way initially. I could go back and change it (move paragraphs around), but no one will reward me for spending time making it easier for them.

curi at 10:41 AM on July 30, 2018 | #10507 | reply | quote

Same article, Levine writes:

> Still, you probably shouldn’t lie to your customers about the prices you paid for bonds. That's not legal advice or anything, and the law does seem murky, but in any case, your bank doesn’t want you to do it. Here is a Securities and Exchange Commission enforcement action against Bank of America Corp.’s Merrill Lynch, Pierce, Fenner & Smith Inc. unit, which agreed to pay more than $15 million because its traders lied about RMBS prices to customers from 2009 through 2012. **Obviously** it does not want that to happen any more. [emphasis and links omitted, bold added]

*Obviously* the bank doesn't want something to happen anymore, which makes the bank money, because the bank paid a $15 million fine? That is not obvious. You'd have to consider how dollars it makes the bank. It could be a lot more than the size of the fine.

This is another stupid comment by Levine.

Anonymous at 10:46 AM on July 30, 2018 | #10508 | reply | quote

Same article, apparently the SEC thinks making too much profit on a voluntary transaction is fraud:

> That’s *just* selling the bond for (much) more than Merrill paid for it. There is no lying at all. But the SEC still thinks it’s fraud:

>> Merrill traders did not disclose the excessive mark-ups charged to Merrill customers. Information about those mark-ups would have been important to the investment decisions of those customers. By failing to disclose the excessive mark-ups, Merrill traders acted knowingly or recklessly. Under these circumstances, their conduct violated antifraud provisions of the federal securities laws

All they did is buy something for $X and sell it for (a lot) more than that.

If there was some expectation by the customer that he was buying at market prices – especially if the bank did something to communicate that – it wasn't mentioned. The overall situation in question wasn't explained very well and I didn't research it, but it basically seems like commerce involving sophisticated businessmen. Also apparently the markups in the examples were only 2.1% and 5.4%, despite the 6 figure profits.

Anonymous at 10:56 AM on July 30, 2018 | #10509 | reply | quote

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