The Use of Real Cost as an Efficiency Measure: An Application to Merging Firms

Abstract

IA recurring theme in industrial economics is firm efficiency, yet the state of the art of its measurement is not very far advanced. At one extreme are theoretically elegant methods, based on the estimation of production or cost functions, which present daunting estimation problems. At the other extreme are measures straightforward enough for practical use-such as the rate of return on capital or labour productivity-but which actually measure efficiency in only the most unusual circumstances. We became interested in this problem whilst engaged on a project which studied the economic effects of mergers, as whether firms have increased their efficiency as a result of mergers is obviously of crucial importance. Profitability alone is no guide since one would expect there to be market power effects, especially from horizontal mergers, which might alter prices; in the extreme case profits may rise simply as a result of an increase in monopoly power.1 Despite this, most of the studies of merger impact (for example, Singh [i6], Utton [I 7], Meeks [i i]) use profitability to assess the efficiency of mergers.