Abstract
We examine firms' strategic incentives to engage in horizontal mergers. In a real options framework, we show that strategic considerations may explain abnormally high takeover activity during periods of positive and negative demand shocks. Importantly, this pattern emerges solely as a result of firms' strategic interaction in output markets and holds in the absence of technological and financial reasons for merging. Varying the intensity of product market competition and the industry structure, and allowing for the existence of operating synergies, operating leverage, and merger-related costs generates additional empirical implications. We test the main predictions of the model using parametric and semi-parametric regression analysis. Consistent with the theory, there is a U-shaped relation between the state of demand and the propensity of firms to merge horizontally, controlling for firms' non-strategic incentives to merge. Furthermore, as predicted by the model, this relation is driven by horizontal mergers within relatively concentrated industries, whereas no such relation exists in industries in which strategic considerations are likely to be less important.
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