Vertical Mergers and the Market Valuation of the Benefits of Vertical Integration

Abstract

This paper explores the market reaction to vertical mergers and incorporates into the analysis predictions based on I/O theories. We develop a classification to separate the various types of mergers, and focus on the determinants and wealth impacts of vertical mergers over the period 1979-2002. Abnormal returns for vertical merger announcements are positive until 1996, and turn negative afterwards. Acquirers suffer most of the losses. We present and test several hypotheses based upon some well known I/O theories of vertical integration. We find support for the most fundamental insight in the I/O literature, namely, that vertical mergers generate most value when undertaken in imperfectly competitive markets and when firms have to invest in specialized assets making market exchanges difficult. There is little evidence to support the view that information based contracting problems or price uncertainty, at least as captured in this paper, generate a value maximizing rationale for vertical integration. However, we show that informational asymmetries can increase the value of horizontal mergers.