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(a) (0, 4, or 8 points) What sort of market failure would justify Japan's action with regard to U.S. beef?
Answer. Information problems. Suppose a significant amount of U.S. beef is contaminated with Mad Cow Disease. Japanese consumers would not know which beef was American, and so would be afraid to buy any beef, hurting all producers. Banning imports of American beef would allow them to safely continue to eat Japanese, Australian, and other beef.
(b) (0, 3, or 6 points) What sort of government failure might cause Japan's action with regard to U.S. beef?
Answer. Japanese farmers gain enormously from the ban, since the price of beef in Japan rises as a result. If they pay more attention to the political process than beef consumers, they could get a beef import ban imposed even there is not really any market failure.
Another possibility is that Japanese politicians know the ban is probably not justified, but though voters will not care enough to blame them just because the price of beef rises needlessly, if by chance some beef *did* have mad cow disease,voters would blame them even though they had made the right decision in not banning imports.
(c) (0, 3, or 6 points) Which businesses are allies in the fight to allow U.S. beef into Japan?
Answer. American beef farmers and Japanese restaurants are the main business allies. Japanese restaurants are hurt by the ban because they must raise the price of the dishes they serve that contain beef, which will hurt their sales overall.
2. (40 points) Consider the situation described in the clipping, "Comcast Makes Unsolicited Bid for Disney."
(a)(0, 4, or 8 points) What is Comcast's motivation for this merger? Present evidence for your position.
Answer. Comcast wants to fire the current CEO, Michael Eisner. We can conclude this because Eisner has refused to talk about a merger with them, and Eisner has been heavily criticized by Disney shareholders Roy Disney and Stanley Gold and by Institutional Shareholder Services. We read that "Comcast's Steve Burke, the head of the company's cable division and a former Disney executive, sounded many of the same notes as dissident shareholders Roy Disney and Stanley Gold." Eisner recently failed in an important task: "talks to extend Disney's lucrative deal with Pixar Animation Studios collapsed"
Comcast also will make at least two big policy changes:
[2] Burke also criticized Disney's $5.3 billion purchase of Fox Family Worldwide, a deal Eisner has admitted was a mistake at that price. The company has not succeeded in boosting ratings or profits at its renamed ABC Family Channel.
"We believe it operates at around break even," Burke said. "We can help address this underperformance."
[1] "We think restoring Disney animation to its rightful place is important," Burke said, echoing a major criticism levied by Roy Disney. "Our goal would be to again place Disney animation in the center of the company."
A tempting answer, but a wrong one, is that the merger will be profitable for Comcast because of synergies between it and Disney--that the merger will reduce costs and increase revenues. It is a wrong answer because there is no evidence for synergies, and lots of evidence that Comcast thinks Disney is badly managed. Merging two companies does not automatically reduce costs and increase revenues-- in fact, it is more likely to increase costs and reduce revenues, since it is harder to manage a big company and the merger process itself hinders operations. Do not be fooled by the assertions of journalists or managers that a merger will create synergies-- these are usually just puffery to cover up other motives.
The Comcast CEO said, "This is a very exciting moment," and the combination "would create one of the world's premier entertainment and communications companies, and, we believe, restore the Disney brand to prominence and the company to growth." That doesn't mean anything. It states the obvious: (a) takeover battles are exciting, (b) the merger would create a big company, and (b) Comcast thinks it can make Disney work better as a company. Note, too, that (a) Comcast is already one of the world's premier entertainment and communications companies, and (b) so what?-- profitability should be the company's aim, not size.
Also, it is wrong to say that Comcast wants the merger because Disney has valuable assets. That is a reason Comcast would be willing to acquire Disney if Disney were available for free, but not a reason why Comcast would pay a premium above the market price. To explain a premium, we need to find a reason why Disney is worth more merged with Comcast than it is worth as a stand-alone company.
(b) (0, 4, or 8 points) Why does the article say that "other potential suitors in the media industry would surely face tougher regulatory scrutiny in Washington"?
Answer. Comcast is a cable company, not a movie or TV production company. Thus, it does not compete substantially with Disney now, and there is no anti-trust concern with the merger (it would be a conglomerate merger). Other potential suitors do make movies, and so might have their merger blocked by Justice or the FTC.
(c) (0, 3, or 6 points)Why did Eisner personally reject Roberts' offer to enter into discussions about merger?
Answer. Eisner does not want a merger that would result in his getting fired, whether or not that would be good for shareholders. Thus, negotiations would be a waste of his time.
(d) (0, 3, or 6 points) One analyst in the article says that Comcast "might be biting off more than it can chew." Why does he say that, and where might his reasoning be faulty?
Answer. The analyst said this:
Kim also said Comcast is basically a cable company, and might be biting off more than it can chew. "I think they underestimate the complexity of being a broad-based media company," he said.
Mr. Kim thinks that Comcast, being a more specialized company than Disney and in a different business, would find it difficult to manage Disney.
The flaw in his reasoning is that it assumes that Comcast would try to micro-manage Disney. Comcast does not give signs of intending to do this. Rather, they are likely to just follow the advice of the dissident shareholders, firing Mr. Eisner, emphasizing animation more, etc. , rather than coming up with any new strategies. In fact, Comcast could just buy Disney, fire Eisner, and then spin it off again under better management.
(e) (0, 3, or 6 points) The price of Disney rose after the offer, but it rose above the price offered by Comcast. Why? What does this tell us about the reason the merger would be profitable?
Answer. The price rose above that offered by Comcast because shareholders put some probability on a better offer appearing--- either a better one from Comcast, or from some other company offering a better merger deal.
It is unlikely that Comcast would make a better offer unless there was a competing offer first, so it seems that people think some other company could raise the value of Disney as much as Comcast could. This suggests that the reason for the merger is not any special synergies with Comcast, but rather is some way to raise Disney's value that more than one company could provide. It is further evidence, in fact, that just firing Eisner would raise Disney's value-- and any merger partner could do that.
Note that the question is not just why the price rose above its price before Comcast made its offer. The naturally would rise then, since if Comcast is successful, all the stock will be bought at the price offered by Comcast. The question is why the price would rise above the price offered by Comcast.
(f)(0, 3, or 6 points) If instead of being bought by Comcast, Disney were bought by the government, would you expect the quality of its management to rise, or to fall? Why?
Answer. I would expect the quality to fall. If Disney were bought by the government, then it would be subject to all the problems of government failure. Ultimately it would be owned by the voters, but they would not pay much attention. Since the stock would not be traded, neither would stock analysts, and there would not even be a public stock price to give an indication of how well management was doing. Nor would there be GAAP accounting and a reliable bottom line.
In addition, the politicians who would control Disney would not have enough incentive to impose good management even if they could figure out how well management was doing. For the politicians, efficient management would be less important than management which would run the company so as to help their political careers. Or, politicians might simply neglect the question of management, since there are other things to occup their time that voters care much more about.
3. (20 points) The FTC thinks that a proposed merger would cause a price increase of 17%, but that as a result the industry would sell only 70% of its current quantity. The FTC also says estimates that the industry's average cost would fall by 5%.
(a) (0, 5, or 10 points) Using the following table, what can you say about whether the merger would increase or reduce the sum of producer and consumer surplus?
Answer. If a price increase of 17% causes output to fall 30%, the elasticity is a little under 2. From the table below, which is taken from the Viscusi book, if the elasticity is 2 and the price increase is 20%, then costs must fall by 5.76% or more for the merger to raise total surplus. That is pretty close to the situation described here, so it looks like total surplus would stay about the same.
(b) (0, 5, or 10 points) Would the courts agree that what happens to the sum of producer and consumer surplus is the proper criterion for determining whether the merger should be allowed under the Clayton Act?
Answer. No. As described in the Verizon case and the Viscusi text, this criterion has been proposed by some economists, but it is not what the Clayton Act says, and judges do not use it. Some judges have moved a little in that direction, and a merger might be allowed if it would reduce prices to consumers even if it still reduced competition. But that is saying that a merger would be allowed if consumer surplus rises, not that it would be allowed if consumer surplus falls by less than producer surplus rises.
| %Price | ...................... | Elasticity of demand | ............................ | ............................ |
|---|---|---|---|---|
| Increase | 3 | 2 | 1 | .5 |
| 5 | .43% | .28 | .13 | .06 |
| 10 | 2.00 | 1.21 | .55 | .26 |
| 20 | 10.37 | 5.76 | 2.40 | 1.10 |
4. (20 points) (0, 5, 10, or 20 points) If Hollinger sells a Smithville newspaper to Gerogi, is it legal for the contract to include a clause saying that Hollinger agrees not to compete in the Smithville market after the sale? If Hollinger does not sell the newspaper to Gerogi, would it be legal for Gerogi to agree not to enter the Smithville market in exchange for a payment of $40,000? Your answer should say not only what the law is, but the reasoning behind the law.
Answer. Yes, the clause is legal if Hollinger is selling an existing newspaper. As Judge Taft explains in Addyston Pipe, the clause is "ancillary" to the main purpose of the contract, which is to sell the newspaper. The economy works better if contracts are allowed, and there are often good reasons to allow noncompete clauses--- they can encourage sales that benefit both parties and consumers as well. In the example here, the sale with that clause would not change the degree of competition in Smithville, because one seller (Hollinger) is simply replaced by another (Gerogi).
If, on the other hand, Gerogi was simply paid $40,000 not to enter, that would be a "naked" restraint--- uncovered by any legitimate purpose, and clearly intended just to reduce competition. That would be a criminal offense. The reasoning is that this reduces competition without any good side-effect, which will lead to higher prices, triangle losses, etc.
5. (15 points)(0, 5, 10, or 15 points) Suppose Congress passes a law saying that "ugly people cannot appear on TV". Describe the process by which the executive branch would make regulations implementing such a law. If ugly actors wished to render the law ineffective, what might they do?
Answer. Some agency would be in charge of creating the regulation. It would draft a regulation and send it to the OMB for approval. If approved, it would publish the proposal in the Federal Register for public comment. After the comment period, it would prepare a final rule and send it to OMB. On approval, it would publish the final rule in the Federal Register.
The best things ugly actors could do is to lobby to get the regulation written to define "ugly" to mean something like "hideously deformed, so as to cause disgust in the eyes of any reasonable person". Since no actors are that ugly, the law would be effectively nullified.
Simply objecting to the law is not going to work, since the law is already in place. Challenging a law or regulation in court usually fails too. Almost always, someone who objects to a law that has just been passed needs to accept that he's lost that battle already and move on to try to narrow the regulation as much as possible.
If you take one lesson away from what you've learned about the rulemaking procedure, it should be this: the agency has lots of discretion in how to write the regulation, and it is important for businesses to lobby hard to get the regulation written the way they want it.
6. (15 points) (0, 5, 10, or 15 points) Ordinarily, the Invisible Hand leads output in a free market to be the output which maximizes the sum of consumer and producer surplus. Explain, using diagrams or careful verbal reasoning, why this might not be true in the market for tires because of information problems.
Answer. It is hard for a consumer to know the quality of a tire without regulation. This could give rise to two possible problems.
First, it might be that consumers are fooled into paying more for tires than their true value to the consumer. Thus, a consumer might pay $50 for a tire, thinking it has a value of $65 to him, for $15 in consumer surplus. If the tire is of lower quality than he thinks, he might find it is only worth $30 to him, and his actual consumer surplus is negative $20. If the producer surplus is only $5, because it costs the seller $45 to produce the tire, the transaction has reduced total surplus by $15.
Second, it might be that no consumer is fooled, but all consumers are wary and decide not to pay more than the value of a tire of minimal quality. Suppose consumers can tell that a tire is worth $20 to them, but they can't tell beyond that whether it is a high quality tire worth $70 or just a $20 value. Sellers will react by producing only the cheap tires, since nobody would pay more than $20. This would result in lost gains from trade between buyers who would pay up to $70 and sellers who could produce a high quality tire, for, for example, $30.
When U.S. health and agricultural officials try to push Tokyo this week to resume buying American beef, they are likely to face tough resistance from the Japanese government. But they will also find vocal support from Japan's $117 billion restaurant industry.
Japan banned imports of U.S. beef last month after the discovery of a case of mad-cow disease, officially known as bovine spongiform encephalopathy or BSE, in a cow in Washington state. Japan, which is the U.S.'s top beef importer by value and which bought $900 million of American beef in 2002, says it wants the U.S. to implement stricter testing measures to ensure its beef is safe. A meeting is expected tomorrow.
The import freeze is hurting Japanese restaurants, many of which rely on U.S. beef because it can cost about half the price of Japanese beef. Now supplies in the restaurants' freezers are dwindling. The shortage was exacerbated this week, when the Japanese government ordered wholesalers to refrain from selling certain types of U.S. beef imported before the import ban. The order includes T-bone steaks, which are cut from near the vertebrae, as well as other beef cuts using the bones or brains of the animal. Brain and spinal tissue from an infected cow is thought to contain the highest risk of passing on the disease.
In an unusual move for Japan -- where public support is traditionally scant for U.S. demands to open its markets -- Japanese restaurant chains are now proclaiming that U.S. beef is safe, and are demanding that the Japanese government allow imports. Last week, the Japan Food Service Association, a trade group, sent a letter via the U.S. embassy to President Bush, asking him to quickly propose new measures that are persuasive enough to sway the Japanese government.
Mad-cow disease is believed to spread to humans who eat infected beef, though there aren't any known cases of people catching the human version, variant Creutzfeldt-Jakob disease, from eating U.S. or Japanese beef.
Yoshinoya D&C Co., Japan's largest chain serving sliced beef over a bowl of rice, is one of U.S. beef's most outspoken supporters. Days after last month's discovery of the sick cow in Washington state, the 1,200-outlet chain held a news conference declaring that almost all of its beef is American, and that it will continue serving U.S. beef in Japan. Beef from Australia or Japan just doesn't taste as good in its "beef bowls," which cost a modest $2.60 per helping, the company says. So if the import ban continues and its beef supply runs out -- probably in the next few weeks -- it says it will have no choice but to stop selling its flagship beef bowls altogether.
Switching to non-American beef "would just end up damaging our brand," declares Hisashi Ikegami, managing director at Yoshinoya. Grain-fed cows from the U.S. create just the right marbling in beef that is suitable for the restaurant's special soy and ginger sauce, the company says. While Australia has reported no cases of mad-cow disease, the company claims that grass-fed Australian cows have tougher meat that turns an unappetizing yellowish color when marinated in its sauce. The company serves U.S. beef in its 82 outlets in the U.S.
Jonathan's Co., a family restaurant-chain operator that buys 40% of its beef from the U.S., also says it wants to continue to use American beef because prices are cheaper than Japanese beef. The import ban has caused already-high Japanese beef prices to soar. Wholesale prices of Japanese beef of comparable quality to imported U.S. beef have risen 34% since the ban.
For now, Yoshinoya is trying to stretch out its beef supply by offering a sprinkling of alternatives on its menu, including curry, fish and chicken bowls. But that may be insufficient to lure longtime fans such as Kenichi Nezu. The 32- year-old Internet-company employee recently headed to Yoshinoya for one last beef bowl.
"Yoshinoya without beef bowls is not my image of the restaurant," he says.
ORLANDO, Fla. (AP) - Cable television giant Comcast Corp. (CMCSA) made a surprise bid for The Walt Disney Co. that would create the world's biggest media conglomerate and likely spell an end to the 20-year career of Disney chief Michael Eisner.
Comcast, which said Eisner had rejected the idea of private talks, stunned the media world with its announcement early Wednesday. It was made just before Disney started two days of meetings with analysts at its flagship Walt Disney World theme park and hours before Disney was set to announce strong first quarter earnings.
The bid was initially valued at $54 billion, but investors bid up the price of Disney stock beyond the Comcast offer - a signal that Comcast would have to sweeten its bid to be successful.
Disney's board released a statement saying it would "carefully evaluate" Comcast's offer. But the board cautioned shareholders not to take any action in the meantime.
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Disney shareholders will gather for their annual meeting March 3 in Philadelphia, where, coincidentally, Comcast is based.
Comcast, the nation's biggest cable systems operator, said it would also assume $11.9 billion in debt from Disney, which also owns ESPN, movie studios and theme parks.
The proposal came as Eisner is fending off criticism from former board members Roy E. Disney, the nephew of Disney founder Walt Disney, and Stanley E. Gold about his performance and lack of a succession plan as Disney's chief executive. That pressure increased late Wednesday, when Institutional Shareholder Services, an influential shareholder group, recommended against Eisner's re-election to the Disney board, citing "blurred" lines between the board and management.
Comcast said Eisner declined earlier this week to discuss a possible merger.
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As if to answer the bid, Disney released its first quarter earnings hours before originally planned.
The earnings easily beat analyst expectations and, Eisner said in a statement, showed the company was firmly on a turnaround that would see 30 percent earnings growth this year and double digit growth until at least 2007.
Eisner made a brief reference to the bid at the beginning of a conference call to discuss the earnings, saying the board had asked Disney's management and advisers to "to provide an in-depth analysis of the proposal to enable the board to respond appropriately."
Analysts said the combination made sense, but questioned whether Comcast would sweeten its offer sufficiently.
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Analysts were not surprised that Comcast, which has access to cable subscribers, would be interested in Disney, with its suite of top-rated cable channels and visible brand.
But they were taken off guard by the timing. Disney's stock, which has lagged over the past six years or so, has risen sharply over the past 12 months and earnings have also climbed on the strength of Disney's film slate and a turnaround at its theme parks.
But Eisner has been under heavy pressure as talks to extend Disney's lucrative deal with Pixar Animation Studios collapsed and dissident shareholders raised questions about the independence of Disney's board.
"It's going for the jugular," said Paul Kim, senior media analyst at Tradition Asiel Securities. "He (Roberts) is using this vulnerable time to force Disney's hand."
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In a conference call Wednesday, Comcast's Steve Burke, the head of the company's cable division and a former Disney executive, sounded many of the same notes as dissident shareholders Roy Disney and Stanley Gold.
"We think restoring Disney animation to its rightful place is important," Burke said, echoing a major criticism levied by Roy Disney. "Our goal would be to again place Disney animation in the center of the company."
Burke also criticized Disney's $5.3 billion purchase of Fox Family Worldwide, a deal Eisner has admitted was a mistake at that price. The company has not succeeded in boosting ratings or profits at its renamed ABC Family Channel.
"We believe it operates at around break even," Burke said. "We can help address this underperformance."
In a news conference in New York, Roberts said he hoped to make the deal "as friendly and amicable as possible, as fast as possible," but he also noted that he was ready to abandon the proposed merger if need be. "We've walked away from big things before. Life goes on," Roberts said.
Comcast also released a letter sent to Eisner indicating that Eisner had personally rejected Roberts' offer to enter into discussions about a merger earlier in the week.
The letter from Roberts called it "unfortunate" that Eisner was not willing to enter into discussions. "Given this, the only way for us to proceed is to make a public proposal directly to you and your board," the letter stated.
Under the merger, Comcast said it would issue 0.78 of a share of its Class A stock for each Disney share, and Disney shareholders would retain 42 percent of the combined company. The offer valued each Disney share at $26.49, a 10 percent premium over their closing price Tuesday.
That's a relatively small premium for a takeover offer, but Comcast may be counting on the fact that other potential suitors in the media industry would surely face tougher regulatory scrutiny in Washington. Most of Comcast's holdings are in cable TV systems, while Disney's are in broadcast, cable and "content" businesses like movie studios.
In a sign that investors expect an extended fight, Disney's shares shot up $3.52, or 15 percent to $27.60 in very heavy trading on the New York Stock Exchange, above Comcast's current offer. Comcast's Class A shares tumbled $2.70, or 8 percent, to $31.23 on the Nasdaq Stock Market.
Disney and Comcast together had $45 billion in revenues last year. If a deal is reached to combine the companies, they would edge out Time Warner, which had $39.6 billion in revenues last year, atop the heap of media and communications companies.
Comcast merged with AT&T Broadband in November 2002, making it the largest cable TV company in the country with 21 million subscribers.
Comcast has several holdings in media content, but has made no secret of its ambitions to acquire more. It has majority stakes in Comcast-Spectacor, the owner of the Philadelphia Flyers and 76ers; Comcast SportsNet, E! Entertainment Television, the Style Network, Golf Channel, Outdoor Life Network and G4.
