Keywords

JEL Classifications

The term ‘endogenous mergers’ reflects the view in economic theory that mergers are equilibrium outcomes. The literature on endogenous mergers explicitly analyses firms’ incentives to merge and makes predictions on the volume and type of mergers that are likely to occur. In this literature, merger formation is modelled as a bidding game or non-cooperative coalition formation game (Kamien and Zang 1990; Gowrisankaran 1999; Nocke 2000; Pesendorfer 2005), or as an anonymous merger market where firms can buy or sell corporate assets (Jovanovic and Rousseau 2002; Nocke and Yeaple 2007). The literature on endogenous mergers is conceptually distinct from the literature on exogenous mergers, which considers the positive and normative effects of a merger between a given (‘exogenous’) set of firms.

To analyse the endogenous merger process, one first needs to understand why firms may want to merge. Several motives for mergers have been identified in the literature.

First, firms may want to merge to realize efficiency gains or ‘synergies’. Mergers may allow firms to exploit complementarities in their capabilities (Nocke and Yeaple 2007), or they may be an efficient way to reallocate used capital from less productive firms to more productive firms (Jovanovic and Rousseau 2002).

Second, firms may want to merge to increase their market power. However, as Salant et al. (1983) have shown for the Cournot model, a merger solely aimed at increasing market power may not be profitable: to the extent that merging firms want to reduce joint output to raise price, non-participating outsiders will increase their output in response, imposing a negative externality on the merging firms. (This point relies heavily on the Cournot assumption; see Deneckere and Davidson 1985.) While it has generally been acknowledged that horizontal mergers (between firms competing in the same market) may lead to higher prices and lower welfare, the Chicago School of antitrust has long held the view that vertical mergers (between upstream suppliers and their downstream customers) are efficiency-enhancing. By showing that vertical mergers may allow foreclosure of upstream suppliers or downstream buyers, this view has recently been refuted in a series of articles (see Rey and Tirole 2005, for a survey).

Third, firms may want to merge to facilitate collusion. A horizontal merger may facilitate collusion by reducing the number of players in the industry, or by reallocating industry capacity in a way that equalizes firms’ incentives to cheat (Compte et al. 2002). A vertical merger may facilitate upstream collusion by reducing the number of downstream outlets through which an upstream firm can profitably deviate. Furthermore, to the extent that collusion is sustainable only if the vertically integrated firm receives a larger market share than an unintegrated firm, firms may have an incentive to merge so as to demand and obtain a larger share of the collusive pie (Nocke and White 2003).

Finally, a variety of other motives for merger have been proposed, some of which are based on the view that firms do not necessarily maximize profits. For example, it has been argued that managers may have an incentive to engage in empire building.

Focusing on the market power motive, much of the recent literature on endogenous mergers has been concerned with studying the limits to monopolization through mergers and acquisitions, and making predictions on the relationship between concentration levels and industry characteristics (Kamien and Zang 1990; Nocke 2000; Gowrisankaran and Holmes 2004). The starting point of this literature is the observation by Stigler (1950, pp. 25–6) that ‘the promoter of a merger is likely to receive much encouragement from each firm – almost every encouragement, in fact, except participation’.

To understand Stigler’s point that a merger to monopoly may not obtain even when feasible, consider an industry with N firms, each running a single plant to produce a homogeneous or differentiated good. If a subset of these firms merge, they will internalize any externality in the price/output decisions they impose on each other. Unless efficiency gains from merging are large, a merged entity would thus produce a smaller output per plant than a single-plant firm: a firm participating in the merger (‘insider’) would be better off than a firm not participating (‘outsider’). Let Π(N; 0) denote monopoly profits, and Π(1; N − 1) the profit of a single-plant firm competing with a larger firm owning N − 1 plants. Assume the merger would take place even when only N − 1 firms agreed to merge. Then, firm i will agree to merge with its N − 1 rivals only if Π(1; N − 1) ≤ siΠ(N; 0), where si is firm i’s equity share in the merged entity. Since this must hold for any firm i, merger to monopoly will occur only if Π(1; N − 1) ≤ Π(N; 0)/N. In standard oligopoly models, this inequality is often violated if efficiency gains from merging are small, the number of firms is large, and competition is not too ‘tough’. Merger to monopoly may thus fail to occur, even though it would maximize joint profits, as some firm(s) may be better off staying outside and taking a free ride on the merged entity’s effort to restrict output.

There may also be limits to monopolization through mergers and acquisitions because of entry. To the extent that a merger makes the industry less competitive, a merger between incumbents may induce more entry in the future, reducing the incumbents’ profits. By not merging with their rivals, incumbent firms may thus credibly commit to compete vigorously and deter further entry.

See Also