An interview with Tony Freyer: Italics signify the interviewer's questions.

Haven't there been historical periods of growth of big business, especially by mergers and other combinations?

Yes, absolutely. The standard literature—at least from a business history point of view—is that you have these cycles of mergers that more or less follow the business cycle. The first and most significant period was around the turn of the century, from 1895 to 1904. That's bracketed by the the Sugar Trust decision and the Northern Securities case. During that period, according to business historian Alfred Chandler, two broad changes occurred: The first, and most important, change was that virtually all of the major manufacturing companies that came to dominate the first two-thirds of the 20th century were actually created out of mergers during the so-called "great merger wave." Think of the major chemical companies, major manufacturing companies: American Tobacco, Standard Oil, DuPont. Eighty to 90 percent of them were established in that great merger wave. The second point to remember about that great merger wave is that the Supreme Court decisions interpreted the Sherman Antitrust Act to approve holding company mergers, which had been legalized in New Jersey for the first time in 1889. Merger rules were broadened by the so-called Delaware Company Law, which, of course, now shelters most major corporations in America.

At the same time, the Court began consistently holding that the Sherman Act prohibited cartel agreements (i.e. market agreements among independent companies). Europe legalized such anticompetitive agreements among small companies, permitting their survival; in the U.S., however, small firms were vulnerable to takeovers by the big companies under those state merger laws.

The second merger wave occurred during the 1920s, following World War I. The corporate giants replaced holding companies with mergers establishing an oligopolistic market structure until there were only a few competitors left. For example, after the turn of the great merger wave, there were seven major automobile manufacturers; by the 1920s, there were four.

During the Great Depression and World War II, mergers rarely occurred, but these oligopolized companies began experimenting with a financial strategy that American antitrust law also permitted. During the '30s productivity collapsed, and then during the war, there was enormous productivity, but the government controlled it. In this state of flux, big corporations developed specialized divisions applying research to develop a wide range of consumer products. Basically, the antitrust laws sanctioned within broad limits this sort of corporate diversification. At the same time, though, the government continued to shut down cartels. Cartels continued to be illegal per se, except for one broad area involving trade associations, which shared certain kinds of information.
During the 1960s, another merger wave occurred; it employed the diversification strategy to form conglomerates. A conglomerate merger pushes the diversification strategy into unrelated product divisions. So, for example, International Telephone & Telegraph, which had communications technology, started buying Marriott hotels and Avis Rent-a-Cars. This conglomerate merger wave came to an end in the mid-1970s, primarily because of the first OPEC oil shock. It is important to remember that initially Nixon went along with applying antitrust rules to prevent the conglomerates, but then he reversed course. As a result, across all industrial sectors, U.S. business searched for more efficient modes of organization. The key development was a new collaboration between lawyers and corporate finance experts to develop leveraged buyout techniques (LBOs).
In the 1980s, the legal-finance investment firms used the leveraged buyout techniques to take over firms to shed unprofitable divisions and in order to put together profitable conglomerates. Under Ronald Reagan, the antitrust restrictions against mergers were so reduced that merger activity increased. Facilitating all of this was the Hart-Scott-Rodino Act of 1976, which required all companies seeking to merge or divest to register under the Act. The law instituted an antitrust notification system, which had existed in Europe and Japan for a long time as part of the cartel system.

This Act created considerable transparency providing just the information these takeover people needed. The merger wave of the 1980s ended as a result of the great stock market crash of 1987 and the savings and loan scandals of the late '80s. Following the recession of 1991 and 1992, the Clinton Administration pursued an economic program centered on lowering interest rates. That, combined with the political effectiveness of ending the budget deficit, spawned the boom of the 1990s and an accompanying merger wave, which technically led to the longest period of growth in the 20th century. I say "technically" because there was a mild recession in 1960-61 which broke the almost continuous growth period of 1945-1971.

What reasons have been put forth in favor of the growth of large business and for mergers and combinations?

The first great merger wave, and indeed, the merger wave of the 1920s, were generally mergers in companies of the same market sector, called "horizontal mergers." But what happened in the '60s and what has happened since, is that aforementioned diversification strategy. That is: antitrust was successful in preventing these oligopolistic industries from becoming monopolies, but it couldn't succeed in breaking up the oligopolistic industries into many small companies. In the first two merger waves, studies reveal, many horizontal mergers failed. In fact, more failed than succeeded. One conclusion from this is that those merger waves, in effect, resulted in the survival of the fittest few. Thus, GM, Ford, and Chrysler prevailed over Studebaker. DuPont and 3M were the leading chemical companies. Those companies, according to Chandler, developed a managerial structure, pioneered by Alfred Sloan and other GM and DuPont managers, that effectively decentralized companies in an organizationally effective way. In many other industries, however, such as textiles, even great managers were unable to develop an underlying technological base primarily because of international competition.

Haven't such reasons included efficiencies via rationalization of capacity and reduction in transaction costs?

The key is the marrying of some degree of operational capability and managerial centralization, and you can call that rationalization and so forth, but what you have to remember is that there are only some sectors in which it has worked. It is not a general or universal law that always works. It is not the Chicago Economic Theory holding that almost all mergers are good—you have to recognize that there is this diversity based on sector.

There are also explanations that rely on what are called economies of scale and economies of scope. They help to explain why the managerially centralized firms that are effective are effective, because those managers have operational expertise that enables them to exploit a firm effectively—to exploit these economies of scale and economies of scope. But, I would also argue, there are firms in industrial sectors, such as textiles, that can't do that.

Now, it is also true that during the '80s, the "international competition" argument was used to justify the "all mergers are good" approach. In foreign countries, particularly Europe and Japan, that rationale obscured the degree to which, as a result of World War II, these countries began to develop their own antitrust regimes that began operating in a way that was similar to the U.S. antitrust regime. The parallel is not exact, but you begin to see, for the first time, these nations and the European community applying the antitrust law to prohibit most cartels in the same way it happened in the U.S. What that did, then, was to encourage greater merger activity, and these antitrust authorities began to differentiate which mergers were OK in much the same way that developed in the U.S. So, you do have this international competition, but it was international competition that ironically resulted in part from the internationalization of antitrust. The Reagan Administration was saying that all mergers are good, in part because we've got this international competition. Ironically, the claim was made against countries in which antitrust was being enforced to make their companies competitive with U.S. firms. It was a circle.