Excess Capacity, Cyclical Production, and Merger Motives: Some Evidence from the Capital Markets

Abstract

THE theoretical foundations of merger are weak and ad hoc; however, recent advances in the theory of the firm pave the way for a construct that may help alleviate this problem. The purpose of this article is to explore the theory of cost in search of a stronger, though not necessarily general, theory of merger. Firms sometimes face demand insufficient to support production at the cost-minimizing rate. They respond by producing more slowly and periodically idling their facilities.2 This implies that intermittent excess capacity might prompt a firm to expand its product line through merger to reduce idle capacity and minimize production costs. In this article we present evidence that these cost-related issues are an empirically important motive for merger. Differentiating between so-called cost-based and monopoly mergers presents a problem of considerable magnitude for antitrust law enforcement authorities.3 Potentially a means of acquiring market power, merger