Conventional antitrust enforcement tries to prevent harmful mergers by blocking them but empirical evidence shows that rival stock prices often rise when a merger is blocked—suggesting that many blocked mergers would have increased competition. In other words, we may be stopping the wrong mergers.
In a clever proposal, Ayres, Hemphill, and Wickelgren (2024) argue that requiring merging firms to short the stock of a close competitor would powerfully realign incentives.
Suppose firms A and B want to merge. Regulators allow the merger on one condition: A-B must take a sizable short position in firm C, a direct competitor. If the merger is anti-competitive and leads to higher industry prices, C’s profits and stock price rise, and A-B takes a financial hit. But if the merger is pro-competitive and drives prices down, C’s stock falls and A-B profits.
A short creates two desirable effects:
- Selection Effect: Only those mergers that are expected to lower prices (and hurt rivals) are financially attractive to the merging parties.
- Incentive Effect: Post-merger, A-B has less incentive to raise prices because doing so boosts C’s stock price, triggering losses on the short.
The short isn’t perfect. Markets might be too shallow, or the rival’s stock could rise for unrelated reasons which imposes extra risk. The authors suggest fixes: instead of a short, require the firm to write Margrabe-style call option. These options have strike prices which float relative to another asset, for example a market or industry price. In this case, A-B would be penalized not if the market as a whole rose but only if the rival outperforms the market.
But the cleanest solution doesn’t require financial instruments at all. Just tie executive pay to relative performance—make the A-B CEO’s bonus depend on beating C’s performance. This is good for shareholders, aligns incentives even in private markets, and doesn’t require making big public bets.
Shorting your rivals sounds strange. But it’s a clever way to force firms to reveal whether their merger helps consumers—or just themselves. Or as I like to say, a bet is a tax on bullshit.
Hat tip: Kevin Lewis.
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