A Simple Model of Mergers and Innovation

Abstract

We analyze the impact of a merger on firms' incentives to innovate. We show that the merging parties always decrease their innovation efforts post-merger while the outsiders to the merger respond by increasing their effort. A merger tends to reduce overall innovation. Consumers are always worse off after a merger. Our model calls into question the applicability of the "inverted-U" relationship between innovation and competition to a merger setting.

Merger and process innovation

“…Like Denicolò and Polo (2018), our results cast doubts on the robustness of the ''innovation theory of harm'' that is articulated in Federico et al (2017) and played a major role in the European Commission's decision on the Dow-DuPont case and might be used in other cases in the future. Hence, the antitrust authorities need to be more cautious when taking decisions on mergers based on their effects on innovation.…”

“…We provide a new perspective to this debate. We show that if firms invest in process innovation, merger may increase R&D investments even if the merged firm spreads out its total R&D expenditure evenly across its research units, as considered in Federico et al (2017). We also show that merger may increase expected consumer surplus and expected welfare.…”

“…As success in R&D is uncertain, it is not immediate whether it is better for the merged firm to use a single research lab or to operate two research labs. In line with Federico et al (2017), we assume that the probability of failure in innovation is logconvex in R&D investments and the merged firm operates both research labs. Hence, we assume…”

“…In an interesting paper, Federico et al (2017) show that mergers always reduce R&D investments of the merged firms compared to non-cooperation. Denicolò and Polo (2018) show that the result of Federico et al (2017) holds provided the probability of failure in innovation is log-convex in R&D investments, which allows the merged firm to spread out its total R&D expenditure evenly across its research units. If the probability of failure in innovation is log-concave in R&D investments, the merged firm will operate one research lab, and merger may increase R&D investments.…”

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Denicolò and Polo (2018) show that the result of Federico et al (2017), i.e., horizontal mergers reduce R&D investments of the merged firms compared to non-cooperation, holds provided the probability of failure in R&D is log-convex in R&D investments. We provide a different reason for innovation raising merger.

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