Horizontal mergers and innovation in concentrated industries

Abstract

The relationship between mergers and the long run rate of innovation is an open question in antitrust economics. I develop a framework to examine this in a dynamic oligopoly model with endogenous investment, entry, exit and horizontal mergers. Firms produce vertically differentiated goods and may merge with rival firms to gain market power and potentially increase the quality of their product. I extend previous work on dynamic mergers by allowing for products differentiated on quality with competition in prices and an endogenous long run rate of innovation. In equilibrium, horizontal mergers are almost entirely harmful to consumers in the short run, but the prospect of a buyout creates a powerful incentive for firms to preemptively enter the industry and invest to make themselves an attractive merger partner. The result is significantly higher rate of innovation with mergers than without and significantly higher long-run consumer welfare as well. Further results explore the circumstances under which this result is likely to hold. In order for the long run increase in innovation to outweigh the short run harm to consumers caused by mergers, entry costs must be low, entrants and incumbents must both have the ability to innovate rapidly, and the degree of horizontal product differentiation must be low. Alternatively, when mergers can generate innovation directly by allowing firms to combine their products they typically benefit consumers in both the short run and long run.

Killer Acquisitions and Beyond: Policy Effects on Innovation Strategies

“…In Phillips and Zhdanov (2013) a laissez-faire policy not only fosters the entrant's innovation, but also the incumbent's. 13 Mermelstein et al (2020) and Hollenbeck (2020) use computational methods to study the long-run effects of merger policy in dynamic oligopoly models with entry-for-buyout incentives; the latter finds that prohibiting mergers can lead to a lower rate of innovation and lower long-run consumer welfare. By contrast, Kamepalli et al (2020) and Katz (2020) argue that, in the tech industry, a laissez-faire policy may have negative effects on start-up innovations.…”

How Do Start-up Acquisitions Affect the Direction of Innovation?

“…The strategic innovation effect of start-up acquisitions is also studied in Cabral (2018), Bryan and Hovenkamp (2020a), Gilbert and Katz (2021), Hollenbeck (2020), Katz (2020) and Letina et al (2020). In Cabral (2018), Hollenbeck (2020) and Katz (2020) the "innovation for buyout" effect of start-up acquisitions is generally beneficial (see also the discussion in Cabral (2020)), although Cabral (2018) and Katz (2020) also put forward situations in which the "innovation for buyout" effect of start-up acquisitions is harmful. The latter occurs when innovators have a choice between different types of innovations.…”

“…There are at least two important aspects that make start-up acquisitions different from standard mergers. The first is based on the notion of "entry for buyout" in the spirit of Rasmusen (1988), which refers to the idea that the mere anticipation of being bought by giant companies may heavily influence start-up's business strategy (see also Cabral (2020), Hollenbeck (2020), Katz (2020), Letina et al (2020), and Motta and Peitz (2020)). Thus, while building their portfolio of research projects, and anticipating an acquisition, start-ups may pay close attention to the direction large corporations go and give more or less weight to projects that might fit the interests of potential acquirers compared to other, non-rival, projects.…”

Happily Ever After?: Vertical and Horizontal Mergers in the US Media Industry

“…When it comes to horizontal mergers, like in the case of Walt Disney-Fox, innovation incentives are lower than in a competitive environment since it tightens the market structure (Reinganum 2008). Horizontal mergers can facilitate innovation by allowing firms to combine their knowledge as well as financial resources (Hollenbeck 2018). However, cost efficiencies and knowledge spillovers usually do not compensate for the lack of innovation incentives from a welfare perspective (Federico et al 2017(Federico et al , 2018.…”