On Predatory Mergers

Overview: The merger mania that has gripped both the United States and Europe over the past several years is a clear invitation to economic analysis especially in light of the work of Salant, Switzer, and Reynolds (1983). In the context of a standard Cournot model, their work shows that: 1) two-firm mergers are typically unprofitable; and 2) the non-merging firms gain from a merger of two of their rivals. Together, these results offer a powerful theoretical disincentive for merger activity. Statistical evidence on the ultimate impact of mergers further complicates these puzzles. The article says that given the large premium paid to the target firm, it is largely the acquiring firm that suffers from these later profit disappointments. Corporate mergers have taken place at an incredibly rapid pace over the last several years in both the U.S. and Europe. Moreover, the price paid by acquiring firms always includes a substantial premium. These facts stand in striking contrast with much of the theoretical and empirical literature on mergers. That literature suggests that many two-firm mergers should be, a priori, unprofitable. It also suggests that, as a matter of factual experience, many mergers have yielded disappointing returns to the acquiring firm. The model presented here offers a partial reconciliation of these conflicts between the implications of academic research and actual corporate behavior. When the parties to a merger negotiation have inside information regarding the true market strength of the newly created firm, rivals can only infer that information imperfectly from the price paid by the acquiring firm.

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Format: PDF | Size: 32KB | Date: Jan 2003 | Pages: 12