The effects of a percentage depletion allowance on vertically integrated mineral firms and industries : theory and evidence

Abstract

This dissertation investigates two controversial issues concerning the effects of a percentage depletion allowance upon vertically integrated mineral firms and industries. One controversial issue concerns the effect of percentage depletion on the ability of mineral firms to increase profits through vertical merger either upstream or downstream. The second issue involves the relation between the price of a mineral input and the vertically integrated firm's share. These two issues are important for several reasons. First, antitrust economists would like to know what role, if any, percentage depletion plays in determining the structure of the mineral industries. Some economists argue that the depletion allowance creates an incentive for vertical merger in cases where no incentive would exist otherwise. Second, the Internal Revenue Service is frequently unwilling to value the input producer's depletion allowance at the transacted market price set by the integrated input monopolist or monopsonist. It is argued that the price the firm sets for its its input sales or purchases is "artificial" in the sense that changes in input share affect the market price of the input. Third, the Federal Trade Commission argues that percentage depletion makes it profitable for a vertically integrated input monopsonist to post "artificially" high input prices, thereby "squeezing out" independent (nonintegrated) downstream users of the mineral input. In an attempt to settle the controversy surrounding the above two issues, this study offers both theoretical and empirical support for a mathematically more general approach than currently exists. This approach reaches alternative conclusions regarding the role of share in determining input price and the incentive to merge in the presence of percentage depletion. The theory of the vertically integrated input monopolist and the theory of the vertically integrated input monopsonist are developed in order to study the incentive to merge upstream as well as downstream. These theoretical works demonstrate that 1) percentage depletion is not sufficient to motivate the mineral firm to merge either upstream or downstream in the absence of other incentives to merge, and 2) share and input price are unrelated...