Abstract
We demonstrate that the popular Farrell-Shapiro-framework (FSF) for the analysis of mergers in oligopolies relies regarding its policy conclusions sensitively on the assumption that rational agents will only propose privately profitable mergers. If this assumption held, a positive external effect of a proposed merger would represent a sufficient condition to allow the merger. However, the empirical picture on mergers and acquisitions reveals a significant share of unprofitable mergers and economic theory, moreover, demonstrates that privately unprofitable mergers can be the result of rational action. Therefore, we extend the FSF by explicitly allowing for unprofitable mergers to occur with some frequency. This exerts a considerable impact on merger policy conclusions: while several insights of the original FSF are corroborated (f.i. efficiency defence), a positive external effect does not represent a sufficient condition for the allowance of a merger anymore. Applying such a rule would cause a considerable amount of false positives. We thank all participants of the 29th HOS Conference (Marburg, November 2007), the 35th EARIE Conference (Toulouse, September 2008) and the Annual Meeting of the Verein fur Socialpolitik (Graz, September 2008) for a valuable and helpful discussion of this paper. Furthermore, we thank Barbara Guldenring for editorial assistance. (This abstract was borrowed from another version of this item.)
Highlights
The framework for analysing horizontal mergers introduced by Farrell and Shapiro (1990) has become very popular in industrial economics
This allows for a clarified interpretation of an ‘efficiency defence’: the total welfare of a horizontal merger is positive if the positive internal effect overcompensates a negative external effect
Result I: If unprofitable mergers are allowed to be proposed, a positive external effect does not represent a sufficient condition for the allowance of a merger anymore!
Summary
The framework for analysing horizontal mergers introduced by Farrell and Shapiro (1990) has become very popular in industrial economics. Any horizontal merger entailing a positive external effect is deemed to be welfare-enhancing (Farrell and Shapiro 1990: 109, 117; 1991: 1009) This policy conclusion is rooted in a crucial assumption: since rational enterprises will only engage in a merger if the combination increases the profitability of the merged entity compared to the non-merged companies, Farrell and Shapiro (1990: 109, 116; 1991: 1007) assume that only profitable mergers will occur, i.e. the internal effect of rational mergers is always positive. In doing so, they find themselves in line with the majority of industrial economics analyses of horizontal mergers.
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