Why Mergers Reduce Profits And Raise Share Prices-A Theory Of Preemptive Mergers

Why Mergers Reduce Pro…ts and Raise Share Prices ¤

RePEc: Research Papers in Economics, 2001

We demonstrate a "preemptive merger mechanism" which may explain the empirical puzzle why mergers reduce pro…ts, and raise share prices. A merger may confer strong negative externalities on the …rms outside the merger. If being an "insider" is better than being an "outsider," …rms may merge to preempt their partner merging with someone else. Furthermore, the pre-merger value of a merging …rm is low, since it re ‡ects the risk of becoming an outsider. These results are derived in a model of endogenous mergers which predicts the conditions under which a merger occurs, when it occurs, and how the surplus is divided.

Merger waves: a model of endogenous mergers

The RAND Journal of Economics, 2007

We develop a model of endogenous mergers to study their dynamic process. Firms choose whether, when, and with whom to merge. Two necessary conditions are identi…ed for mergers to occur: …rm heterogeneity and negative demand shocks. We show that mergers are strategic complements and therefore tend to occur in waves. Moreover, some mergers occur for strategic reasons in order to precipitate further mergers.

Why Mergers Reduce Profits, and Raise Share Prices

1999

On the welfare effects of mergers: Short run vs. long run

The Quarterly Review of Economics and Finance, 1998

We use a two-period moo!& to analyze the short run and long run pro&b&y and welfare consequences of horiwntnl mergers, where the equilibrium responses to a merger can d@eer over time. Although firms can anticipate the merger, they can only adjust their capa@ in the long run. We Jind a greater range of profitable mergers than in static modek. For a merger to raise welfare, a is su&ent thut the short run welfare effects are positive and necessary that the long run effects are positive. We relate these conditions to the inside jirms' musket shares and the Herfindahl index. J 2 QUARTERLY REVIEW OF ECONOMICS AND FINANCE Recent theoretical work has suggested that horizontal mergers can raise welfare even though concentration is increased. These papers follow the lead of Williamson (1968), who argued that a merger may allow participating firms to lower production costs through economies of scale, synergy gains, sharing technology or information, or a shift from less to more efficient producers (rationalization of production).4 Several of the recent mergers mentioned above featured claims of increased efficiency from the merger. For example, Rite Aid estimated it would save $156 million annually with the merger (WuU Street Journal, 30 November 1995, p. A3). Farrell and Shapiro (1990) find that a horizontal merger can increase welfare even if it causes price to rise, so long as the combined pre-merger market shares of the firms involved in the merger is sufficiently small relative to a weighted average of the other firms' market shares, and the merger is privately profitable.5 In a model where firms have constant but possibly different marginal costs, Levin (1990) finds that any profitable merger between firms whose combined market shares do not exceed 50% will be welfareenhancing. In a model with increasing marginal costs that depend upon a firm's assets, and where a merger combines assets, McAfee and Williams (1992) show that mergers leading to a more symmetric distribution of market shares increase welfare. In contrast to Farrell and Shapiro and Levin, however, they find that no merger involving the largest firm in the industry, or one that creates a new largest lit-m, can be socially desirable. Baik (1995) analyzes a model in which firms first choose capacity and then compete by setting prices. Following a merger, the merged firm is allowed to set capacity prior to capacity choice of other firms. He shows that a merger can result in lower prices, which raises welfare. These models focus on static one-shot games. They do not distinguish between short run and long run effects of a merger. However, firms not involved in the merger may not be able to fully react to the merger in the short run. Empirical evidence suggests there are important differences between short and long run effects. Generally, the combined stock prices of merging firms increase in the short run as a result of the merger. Over the longer term, these gains tend to disappear (

Endogenous Mergers in Vertically Differentiated Markets

2015

This paper studies the incentives for …rms competing in vertically di¤erentiated markets to sign binding collusive agreements, as in the case of mergers and alliances. Empirical investigations show that …rms involved in mergers and acquisitions revise prices and qualities as to maximize their joint pro…ts. In a few cases merging …rms are also observed shutting down some lines of activities (so called market pruning). In this paper we attempt to test these predictions by modelling a three-stage game in which, at the …rst stage, three …rms selling goods independently in a vertically di¤erentiated market can commit to sign either a full or a partial voluntary agreement (with a subset of …rms) via a sequential game of coalition formation while, at the second and third stage they can optimally revise their qualities and prices, respectively. In such a setting we study whether some binding agreements (as full or partial mergers) can be sustained as subgame perfect equilibria of the coalition formation game. Moreover, we analyse the …nal e¤ects of di¤erent coalition structures on equilibrium qualities, prices and pro…ts accruing to …rms. We obtain the following results: (i) initial …rms' heterogeneity appears a crucial factor for mergers to arise; (ii) although pro…table, the grand coalition of …rms (i.e. the whole market merger) is not the outcome of the …nite-horizon negotiation, where only partial mergers arise; (iii) all stable mergers comprehends the …rm producing the bottom quality good; (iv) all stable mergers reduce the number of variants on sale (market pruning); (v) stable mergers always increase the quality gap among variants. All model …ndings seem compatible with the existing empirical observations.

The Welfare Consequences of Mergers with Endogenous Product Choice

The Journal of Industrial Economics, 2018

Merger simulations focus on the price changes that may occur once previously independent competitors set prices jointly and other market participants respond. This paper considers an additional effect-the possibility that market participants change the products they choose to offer after a merger. Using a model that endogenizes both product choice and pricing, we conduct equilibrium market simulations for mergers including the potential for product offering changes in a variety of scenarios. We find that allowing for changes in product offering can have effects on profitability and consumer welfare above and beyond those generated by traditional price responses alone, particularly in cases where the merging parties offered relatively similar products prior to the merger. Cost synergies may also affect product offering decisions, potentially leading to increases in consumer welfare if more products are introduced. The results suggest that analysts carefully consider the impacts of product choice, along with prices, when simulating potential welfare changes associated with mergers.

Endogenous mergers, trade and industrial policy

Joensuun yliopisto eBooks, 2003

Two firms produce differentiated goods in different countries. The owners negotiate over a merger. The standard result is that the owners of a firm obtain their initial profit plus half of the merger surplus. Introducing subsidies/taxes adds a new element because profit shares affect policies and policies affect profit shares. In addition to the disagreement effect, the bargaining solution is determined by how much a firm contributes relatively to the merger profit. Besides, the reversal of policies may make anticompetitive mergers unfeasible.

A simple model of mergers and innovation

Economics Letters

We analyze the impact of a merger on firms' incentives to innovate. We show that the merging parties always decrease their innovation efforts post-merger while the outsiders to the merger respond by increasing their effort. A merger tends to reduce overall innovation. Consumers are always worse off after a merger. Our model calls into question the applicability of the "inverted-U" relationship between innovation and competition to a merger setting.

In Search of Synergy Effects: Mergers and Productivity

SSRN Electronic Journal, 2000

We propose an alternative method for investigating whether firms improve performance through mergers after taking into account the selection bias of merging firms. We simultaneously consider the dynamics of firm performance and the merger decision by employing full information maximum likelihood (FIML) estimation. Our study differs from previous studies in that state dependence, unobservable heterogeneity, and selection bias are incorporated simultaneously. Because the effects of mergers may be felt gradually, the dynamic effects of mergers and the factors associated with these dynamics should be taken into account. Our FIML approach complements the strategy used in the extant literature for investigating the effects of mergers on firm performance.

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