Mark Zmijewski: What CEOs Need to Know About Measuring Cognizable Efficiencies in Proposed Mergers

When a board approves a merger, the business case usually rests in part on expected synergies, the value the combination is expected to create. Antitrust review asks a different question. Under Section 7 of the Clayton Act, the U.S. Department of Justice and the Federal Trade Commission (together, the "Agencies") assess whether the merger may substantially lessen competition, and the Merger Guidelines allow the parties to rebut a showing of competitive harm with proof of cognizable efficiencies: efficiencies that are merger-specific, not anticompetitive, and verifiable.

Synergies and cognizable efficiencies are not the same, and conflating them is a recurring source of confusion for the executives of merging parties. The synergies a board weighs in approving a transaction do not all qualify as efficiencies the Agencies and courts will credit against a merger's potential anticompetitive effects. Once the Agencies establish a prima facie case of likely anticompetitive harm, the parties bear the burden of proving that their claimed efficiencies are cognizable and sufficient to render the merger not anticompetitive. Yet neither the Merger Guidelines nor the case law prescribes the standards, methods, or tests by which a cost efficiency is to be measured and verified.

Synergies and Cognizable Efficiencies Are Not the Same

The value of expected synergies is the present value of the combined firm's expected future cash flows in excess of the present value of the two firms' expected cash flows on a stand-alone basis. It captures every source of value, such as real cost reductions from combining operations, cost reductions achievable without the merger, revenue gains, and financial benefits. Cognizable efficiencies, however, are the subset of those synergies that the Agencies and the courts will credit against a merger's expected anticompetitive effects. (Synergies are covered in more detail in Chapter 16 of Corporate Valuation: Theory, Evidence and Practice by Robert W. Holthausen and Mark E. Zmijewski, with a third edition forthcoming from Sage Publications in 2027.)

As the court stated in United States v. H&R Block (D.D.C. 2011), cognizable efficiencies are a subset of synergies, and synergies refer more generally to any business benefit that results from combining two companies. The difference is one of standard and purpose. The synergy estimate is a business judgment about value created. A cognizable efficiency is a monetary quantification that must be substantiated, measured, and verified by an independent third party, using actual data, against the specific requirements the Agencies set and the courts often apply. Merging companies must therefore adjust a forward-looking synergy forecast, often based on management's business judgment, so that claimed efficiencies are quantified, documented, and independently verified. As the court held in H&R Block, and as the court in United States v. Aetna (D.D.C. 2017) agreed, executives' estimates may be sensible business practice, yet the absence of a verifiable method of factual analysis renders them not cognizable. Were judgment alone enough, the efficiencies defense could swallow Section 7 of the Clayton Act.

The Standard Is Set by the Merger Guidelines

The benchmark for a claimed efficiency is not management's confidence in the figure but the requirements of Section 3.3 of the Agencies' 2023 Merger Guidelines. An efficiency is cognizable only if it is: (1) merger-specific, meaning achievable only through the merger under review, not through organic growth, contract, or acquisition of the relevant assets alone; (2) verifiable by reliable methodology and evidence independent of the parties' subjective predictions; (3) realized within the relevant market and within a short period; and (4) not anticompetitive, meaning not the product of worsened terms for trading partners or of reduced competition in another market. The first, third, and fourth are matters of characterization. Verifiability drives the measurement task and is where claims most often fail.

Why Business Judgment Does Not Produce Verifiable Efficiencies

Management's business judgment is used in pricing a merger transaction because it is based on management's experience and expertise, but that same feature makes it insufficient, standing alone, to prove a cognizable efficiency: it supplies a conclusion without the means to verify it.

The litigated record is consistent. Courts have required rigorous analysis rather than speculation about post-merger behavior, refused to let defendants overcome a presumption of illegality with management's assertions, and rejected savings the parties could not verify or explain. The failure is usually one of measurement. In United States v. Oracle Corp. (N.D. Cal. 2004), senior executives had supplied the figures from personal judgment, and the court held the evidence unverifiable and too speculative to credit. In FTC v. Tronox Ltd. (D.D.C. 2018), a retained advisory firm's synergy model could not be independently verified because it rested in part on the business's own revised estimates.

Verifiability is thus a property of method and data, not of the credentials of the person vouching for the estimate. A claim is cognizable when an independent party, applying standard accounting, economic, and financial methods to actual business data and comparable past transactions, can reproduce it. Courts also test internal consistency. In FTC v. Staples (D.D.C. 1997), the claimed efficiencies presented to the court were roughly five times those shown to the boards and far exceeded the proxy statement figure, a discrepancy that undermined the claim.

What Executives Should Do

The practical recommendation follows from the standard. A company whose transaction may draw antitrust scrutiny should commission an independent third-party efficiencies analysis early, before an investigation begins rather than after, to identify and quantify the efficiency claims that can meet the cognizability standards.

Each claim should be developed the way it will be tested:

● Calculations documented and traceable to ordinary-course business records and to the firm's experience in comparable past transactions.

● Standard, widely accepted methods applied to actual data rather than to management forecasts.

● Output and quality held constant.

● Stand-alone savings excluded, acceleration claims restated as timing value, and any saving that requires both parties' resources supported by evidence that a contractual alternative is impractical.

● Efficiency figures reconciled across the board presentation, the deal model, the public disclosures, and the regulatory submission.

Efficiencies substantiated in this way are the efficiencies the Agencies have credited in clearing transactions, among them Whirlpool/Maytag, Sirius/XM, MillerCoors, and Delta/Northwest, each cleared by the Department of Justice between 2006 and 2008.

About the Author

Mark E. Zmijewski is the Charles T. Horngren Professor of Accounting Emeritus at the University of Chicago Booth School of Business and a Senior Consultant at Econic Partners. He has worked on more than 25 proposed merger cases assessing cognizable efficiency issues, including all of the cases cited in this article.