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.