Evaluating the Performance of Merger Simulation : Evidence from the Hospital Market in California

Antitrust enforcement in the hospital industry has been an area of sharp contention in recent years. Prior to the decision in the Evanston Northwestern case in 2005, the Federal Trade Commission and the United States Department of Justice had lost the last seven hospital cases. One of the reasons for the failure of the government to prevail in these court cases has been their inability to convince the courts to accept their definition of a geographic market. In reviewing mergers, the antitrust enforcement authorities seek to determine what effects the proposed merger would have on prices, quality, and other related aspects of the prospectively merging firms' services. Most commonly, the primary focus is on the effect of the prospective merger on prices. There are a number of different approaches to the evaluation of hospital mergers, and these approaches often lead to differing predictions about the effects of the merger on hospital prices. In this paper we propose a method of hospital merger analysis which relies, in part, on calculating an index of hospital competition called the Logit Competition Index (LOCI). LOCI is calculated using hospital discharge data. Using these data, discharges are organized into types, the market shares of the hospitals in the analysis are calculated within these types, and then these market shares are aggregated together into a numerical index. Changes in this index due to a merger are theorized to predict the price changes caused by the merger. Consequently, our methodology does not require the definition of a geographical market. We apply our method to simulate merger effects of consummated and hypothetical mergers using data of hospitals in the state of California from 1992 to 2004. We find that the wave mergers that happened in California in the 1990's led to substantial increase in price not only for merging firms but also non-merging firms. Finally, because of the long span of our data, we are able to compare our predicted price increase with actual price increase of consummated mergers. Our methodology predicts well actual changes in price due to merger. These results have important implications for merger analysis in hospital markets and also for antitrust enforcement. It presents antitrust authorities with a methodology does not rely on geographic market definition but predicts fairly well price increases due to mergers