Horizontal Mergers and Innovation in Concentrated Industries

Abstract

An open question in antitrust economics is whether allowing rival firms to merge increases or decreases incentives to invest and innovate? I examine this in a dynamic oligopoly model with endogenous investment, entry, exit and horizontal mergers. Firms produce differentiated goods and may merge with rival firms to gain market power and increase the quality of their product. I extend previous work on dynamic mergers by allowing for differentiated goods with competition in prices, more than 2 firms in the market, and an endogenous long run rate of innovation. In equilibrium, horizontal mergers are mostly harmful to consumers in the short run, but the prospect of a buyout creates a powerful incentive for firms to enter the industry and invest to make themselves an attractive merger partner. The result is significantly higher total innovation with mergers than without and significantly higher long-run consumer welfare as well. This result also helps shed light on the larger question of the relationship between the competition and innovation. Further results show that long run welfare is increased most by mergers in industries with low consumer switching costs or brand loyalty, as well as in industries where large and rapid innovation is possible.