Mergers

This chapter studies firms’ incentives to merge in imperfectly competitive markets. Exercise 7.1 begins with the basic setting of mergers between two firms into a monopoly. Exercise 7.2 extends into the setting of mergers between k firms in an industry with N firms. We show that when the number of firms that merge is sufficiently high, mergers become profitable as the gain in market power more than offsets the output increase of the firms that do not merge, and this is referred to as the “80% rule” after Salant et al. (1983). Exercise 7.3 suggests that when there are three or more firms merging together, the merger is unsustainable because every participating firm has incentives to leave and free ride on output reduction of the merger to increase its own output and profit levels. Exercise 7.4, in contrast, studies Bertrand mergers with three differentiated firms, showing that both partial and full mergers are sustainable when firms merge to soften price competition. Exercise 7.5 analyzes Cournot mergers with differentiated products, showing that as firms produce more homogeneous products, competition becomes more intense so more firms need to participate in order to sustain the merger. Exercise 7.6 shows that mergers between horizontally differentiated firms do not increase welfare when firms are relatively symmetric in costs, but are welfare-enhancing when firms are significantly cost-asymmetric in shifting output from the less to the more efficient firm. Exercise 7.7 finds that companies have stronger incentives to merge when the merged firm benefits from cost-reduction effects. Exercise 7.8 suggests that when firms merge to gain economies of scope, they have more incentives to merge than when they suffer diseconomies of scope. Exercise 7.9 finds that if two firms in a homogeneous market of N firms merge to gain Stackelberg leadership, these two firms have incentives to merge under all parameter conditions. Exercise 7.10 analyzes mergers in a sequential-move game. We report that while a leader has incentives to acquire a follower, those incentives are weakened when the follower market becomes more competitive. To summarize, the existence of outsiders weakens firms’ incentives to merge, unless the merged firm gains significant market power, enjoys cost advantage, or maintains output leadership. Exercise 7.11 develops the case for the “tragedy of the anticommons,” where firms, unlike a cartel which limits the extraction of common pool resources, increase the production of complementary goods relative to their competitive levels. Finally, Exercise 7.12 analyzes merger incentives in polluting markets, suggesting that emission fees can facilitate mergers of environmentally differentiated firms.