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Northwestern Journal of International Law & Business Volume 37 Issue 1 Winter Winter 2017 Sherman vs. Goliath?: Tackling the Conglomerate Dominance Problem in Emerging and Small Economies—Hong Kong as a Case Study Thomas K. Cheng Follow this and additional works at: http://scholarlycommons.law.northwestern.edu/njilb Recommended Citation Thomas K. Cheng, Sherman vs. Goliath?: Tackling the Conglomerate Dominance Problem in Emerging and Small Economies—Hong Kong as a Case Study, 37 Nw. J. Int'l L. & Bus. 35 (2017). http://scholarlycommons.law.northwestern.edu/njilb/vol37/iss1/2 This Article is brought to you for free and open access by Northwestern University School of Law Scholarly Commons. It has been accepted for inclusion in Northwestern Journal of International Law & Business by an authorized editor of Northwestern University School of Law Scholarly Commons. CHENG (DO NOT DELETE) 3/6/2017 6:21 PM Copyright 2017 by Thomas K. Cheng Printed in U.S.A. Northwestern Journal of International Law & Business Vol. 37, No. 1 Sherman vs. Goliath?: Tackling the Conglomerate Dominance Problem in Emerging and Small Economies—Hong Kong as a Case Study Thomas K. Cheng*• Abstract: This article explores a competition problem that has been long neglected in the two major competition law jurisdictions, the United States and the European Union, conglomerate dominance or aggregate concentration. With their continental scale, the U.S. or the EU economies are unlikely to be dominated by conglomerates. However, conglomerates have been found to be common in small economies and emerging economies. Conglomerates no doubt have their advantages. Yet they also pose some serious economic power issues and distort competition in a variety of ways, the latter of which has been relatively unexplored in the literature. This article catalogs these issues and distortions and proposes two sets of responses to them: direct regulation of conglomerates and competition law enforcement. These two sets of solutions to some extent alleviate the detrimental effects of conglomerates. However, they do not get to the root of the problem, domination of an economy by large conglomerates. Using Hong Kong as an example, this article illustrates the application of these two sets of solutions and their limitations. * Associate Professor, Faculty of Law, University of Hong Kong; [email protected]. The Author would like to acknowledge the able research assistance of Joel Lee, Allison Wong, Harry Chan, Tommy Cheung, Felix Man, Adrian Yeung, Kate Chan, Cheryl Tang, Cecilia Choi, and Erica Ying. 35 CHENG (DO NOT DELETE) 3/6/2017 6:21 PM Northwestern Journal of International Law & Business 37:35 (2017) TABLE OF CONTENTS I. Introduction .................................................................................... 37 II. The Advantages of Conglomerates ............................................... 39 A. Economies of Scale and Scope ........................................... 41 B. Overcoming Missing Institutions ....................................... 42 C. Risk Sharing ....................................................................... 42 D. Sharing of Group Goodwill ................................................ 44 E. Provision of Internal Capital Market .................................. 45 F. Provision of Internal Factor Market .................................... 47 G. Facilitating Access to International Capital Markets ......... 48 III. The Disadvantages of Conglomerates—Economic Power Concerns................................................................................... 49 A. Corporate Governance Problems—High Agency Costs .... 50 B. Distortion of Access to Financial Markets ......................... 52 C. Crowding out of SMEs and Entrepreneurs ......................... 54 D. Overall Economic Welfare Effects .................................... 54 E. Political Economy Concerns............................................... 55 IV. Conglomerate Distortion of Competition .................................... 58 A. Multifirm Conduct ............................................................. 58 1. Mutual Interdependence .............................................. 59 2. Parallel Exclusion ........................................................ 62 3. Interlocking Directorate ............................................... 64 B. Unilateral Conduct ............................................................. 64 1. Predatory Pricing ......................................................... 65 2. Tying ............................................................................ 68 3. Exploitative Practices by Conglomerate Companies ... 69 4. Entry Deterrence or Loss of Potential Competition ..... 71 5. Cross-Subsidization ..................................................... 73 V. Possible Responses to Conglomerate Dominance ........................ 74 A. Direct Regulation of Conglomerates and Their Internal Operations ......................................................................... 75 1. Direct Restrictions on the Growth of Conglomerates .. 75 2. Direct Restrictions on Intragroup Transactions ........... 77 B. Regulation of Market Behavior .......................................... 78 1. Mutual Interdependence .............................................. 78 2. Parallel Exclusion ........................................................ 79 3. Predatory Pricing ......................................................... 79 4. Tying ............................................................................ 81 5. Abuse of Superior Bargaining Position ....................... 81 6. Entry Deterrence/Loss of Potential Competition ......... 83 36 CHENG (DO NOT DELETE) 3/6/2017 6:21 PM Conglomerate Dominance in Small and Emerging Economies 37:35 (2017) 7. Interlocking Directorate ............................................... 84 8. Merger Review ............................................................ 85 VI. The Case of Hong Kong .............................................................. 88 A. Overview of Competition Law in Hong Kong ................... 88 B. An Overview of Conglomerate Dominance in Hong Kong 89 C. Assessment of Advantages and Disadvantages of Conglomerates in Hong Kong .......................................... 93 1. How relevant are conglomerate advantages in Hong Kong? .......................................................................... 93 2. What is the extent of conglomerate harm in Hong Kong? .......................................................................... 95 D. Possible Responses to Conglomerate Dominance in Hong Kong ................................................................................. 97 VII. Conclusion ................................................................................ 104 I. INTRODUCTION Conglomerates are a competition problem that has been long neglected in the United States and the European Union (EU), the two leading competition law jurisdictions in the world. Due to the size of their economies, they are unlikely to be dominated by any corporate group or groups, no matter how large these groups are. Yet there are a considerable number of countries in the world whose economies are dominated by conglomerates. A survey conducted by this author and collaborator Professor Michal Gal with the assistance of United Nations Conference on Trade and Development shows that a high percentage of the respondent countries are afflicted by high aggregate concentration (in fact, half out of the thirty-two of them are).1 Yet, in no more than twenty percent of them do their competition laws specifically address aggregate concentration.2 One wonders why conglomerates emerge and why they are more prevalent in some countries than others. There are a number of explanations for this. One reason is the small size of the economy. Conglomerates are more likely to emerge in small economies because as a successful firm grows, it will eventually hit a limit imposed by the size of the market, which is constrained by the size of the economy. If it wants to continue growing, it must explore a new market (apart from overseas expansion). Over time, this firm will branch into more and more sectors until it eventually becomes a 1 Michal S. Gal & Thomas K. Cheng, Aggregate Concentration: A Study of Competition Law Solutions, 4 J. ANTITRUST ENFORCEMENT 282, 296 (2016). 2 Id. 37 CHENG (DO NOT DELETE) 3/6/2017 6:21 PM Northwestern Journal of International Law & Business 37:35 (2017) conglomerate. This is especially likely if there is a dominant sector in the economy that dwarfs other sectors in importance, such as real estate, mining, or oil and gas. Firms that are successful in these sectors will have sufficient ammunition to branch out to other sectors. And the heft they have gained in their large home sector means that they will be very well resourced against rivals in the new sector. Hong Kong and Israel are some examples of small economies dominated by conglomerates. Emerging economies have also been found to have a high incidence of conglomerates. This may be due to the various advantages of conglomerates that will be discussed below, such as economies of scale and scope, overcoming missing institutions, risk sharing, and internal capital and factor markets, which are particularly relevant in the emerging economy setting. Firms tend to conglomerate to take advantage of these advantages. And when some firms start to do that, other firms may do so too as a preemptive measure. Lastly, conglomerates may emerge as
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