In this paper we study endogenous mergers in a model of strategic bargaining. We allow for firm asymmetries so that the identity of the merging partners affects the distribution of profits. In particular, we emphasize the fact that potential synergies generated by a merger do vary depending on the identity of the participating firms.
We make two main contributions. The first is to show that relatively inefficient mergers may take place. That is, a particular merger may materialize despite the existence of an alternative merger capable of generating larger synergies and hence higher profits and higher social surplus. Our second contribution is a methodological one. We use a bargaining model that is flexible, in the sense that its strategic structure does not place any exogenous restriction on the endogenous likelihood of feasible mergers.
It is well known that for strategic reasons the occurrence of a merger does not only depend on its relative profitability with respect to the status quo. Unprofitable mergers may take place (preemptive mergers) and, on the contrary, profitable mergers may be delayed (war of attrition). Such "anomalies" are likely to have a positive effect on consumer surplus. Preemptive mergers emerge when they generate sufficiently negative external effects on firms that do not participate in the merger (large synergies). Similarly, firms engage in a war of attrition when the dominant effect is the increase in market concentration. These anomalies occur in our model as well. However, our model also predicts a different kind of anomaly that we can term as an identity failure.
This new kind of anomaly is of a different nature of the ones already identified in the literature. Indeed, the ones discussed in previous papers can be interpreted as instances of coordination failure. Equilibria where a profitable merger is delayed always coexist with other equilibria where the profitable merger takes place without delay. Similarly, equilibria where an unprofitable merger takes place always coexist with no-merger equilibria. Therefore, if players could coordinate their expectations they would be willing to do so. In contrast, the type of inefficiency we have found would survive such coordination of expectations. When mergers are profitable and attractive then the equilibrium is unique, and provided synergies generated by alternative mergers are not too different, then an inefficient mergers takes place with positive probability. Thus, such inefficiency is not caused by any coordination failure, but by a more generic bargaining failure. Unless players are sufficiently heterogeneous, the relatively inefficient firm still enjoys a strong bargaining position, which interferes with the implementation of the efficient merger. Fixing this type of failure would require a binding agreement with side payments among all relevant players.
Hence, our model has important implications for merger control policy.