Merger wave in a small world: Two views

I attempt a more balanced assessment of mergers in terms of systemic risk versus other effects. First, using the simplest network model, I illustrate how mergers can increase systemic risk by reducing the degree of separation among firms. Then, recasting the firms in a simple economic model that features consumers explicitly, I show how a merger wave – a contagious urge to merge – can occur and what benefit it may bring to consumers. Together, these two models suggest that there is a tradeoff to consider: While a merger wave may result in higher systemic risk, it may also bring about higher consumer welfare.

► Firms exist in more than one world. ► Mergers can make one world smaller and another bigger, one world better off and another worse off. ► In the financial world, mergers can bring firms closer to each other, thereby making that world smaller. ► In the economic world, mergers drive firms farther apart, thereby making that world bigger. ► Thus, as firms merge, financial panics and bubbles become more likely, and yet products become better aligned with consumer preferences.