A simple model of mergers and innovation

- We consider a merger in a setting where firms innovate to discover new products.
- We discuss two fundamental effects: externalities of innovation and product market competition.
- The merging parties always decrease their innovation efforts, contrary to the outsiders.
- A merger tends to reduce overall innovation and consumers are always worse off after a merger.
- The inverted-U relationship between innovation and some measure of competition is not applicable to a merger setting.

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.