Entry by takeover: Auctions vs. bilateral negotiations

Firms often enter new markets by taking over an incumbent. We analyze a potential entrant's choice of target under two (exogenously given) takeover mechanisms: (i) auctions, where other incumbents can bid for the target against the entrant, and (ii) bilateral negotiations between the entrant and the target. The entrant's choice of target depends on the mechanism, and it may not maximize its ex-post profit (nor consumer welfare). In an auction, the entrant pays a higher price to take over a target with higher synergies, because these impose stronger negative externalities on incumbents and increase their willingness to pay for preventing entry. Auctions increase the price obtained by the target, but reduce welfare compared to negotiations because they may discourage the entrant from acquiring a target with higher synergies.