Mergers and Innovation Portfolios

Abstract

This paper studies mergers in markets where firms invest in a portfolio of research projects of different profitability and social value. The portfolio nature of the investment problem brings about novel insights on the external effects of firms' investments. The investment of a firm in one project imposes a negative business-stealing externality on the rival firms because it lowers the probability they win the innovation contest for that project; however, the investment of a firm in one project also exerts a positive business-giving externality on the rival firms because it increases the likelihood they win the contest for the alternative project. Merging firms internalize these positive and negative externalities they impose on each other. We show that when the project that is relatively more profitable for the firms is also the more appropriable, then a merger increases consumer welfare by reducing investment in the most profitable project and increasing investment in the alternative (less profitable) project. For the case of linear demand and constant marginal costs, the portfolio effect of mergers makes them consumer welfare improving. With constant elasticity of demand and constant marginal costs, a merger increases consumer welfare if the more profitable project corresponds to the market with the higher elasticity of demand. The portfolio effect of mergers may dominate the usual market power effects of mergers.

Killer Acquisitions and Beyond: Policy Effects on Innovation Strategies

“…11 In models with multiple research approaches, Letina (2016) and Gilbert (2019) obtain negative effects on R&D diversity; Letina also finds that mergers reduce research duplication. Moraga-González et al (2019) 11 A related literature investigates the effects of the number of firms on innovation, see e.g. Yi (1999), Norbäck and Persson (2012) and Marshall and Parra (2019).…”

How Do Start-up Acquisitions Affect the Direction of Innovation?

“…Other papers, more related to ours, have examined how mergers impact the variety and diversity of R&D projects firms engage in (e.g. Letina (2016); Gilbert (2019); Moraga-González et al (2019)). 4A second branch of the literature focuses on the acquisition of potential competitors.…”

“…Second, our model is one of vertical product differentiation and, as it turns out, whether the Arrow replacement effect is larger for the incumbent or for the start-up depends on parameters. 4 In fact, in terms of its model, our paper is related to Moraga-González et al (2019) where mergers between existing firms are examined in a symmetric setting in which firms invest in a portfolio of research projects of different profitability and social value. The main difference between our paper and theirs in that our model is tailored to the phenomenon of start-up acquisitions, which allows us to identify the "innovation for buyout" effect on project portfolio choice.…”

“…Only very recently has the literature incorporated innovation incentives into the analysis of mergers (Federico et al, 2018;Motta and Tarantino, 2017). In doing this, a couple of papers have pointed out that it is important to look at how mergers affect the portfolio of research projects firms choose to engage in (Gilbert, 2019;Letina, 2016;Moraga-González et al, 2019). It is this latest angle that this paper intends to develop within the context of start-up acquisitions.…”

Multiproduct Mergers and Quality Competition

“…These studies typically assume quantity competition(Perry and Porter, 1985;Levin, 1990;McAfee and Williams, 1992) or price competition with horizontally differentiated products(Deneckere and Davidson, 1985).5Moraga-González, Motchenkova, and Nevrekar (2019) show that when firms engage in winner-takes-all innovation contests, a merger may raise consumer surplus by inducing firms to reallocate their efforts across the different contests.6 Papers which use structural methods typically find that merging firms remove or degrade products, while nonmerging firms add or improve products. Depending on which effect dominates, product repositioning can either exacerbate (e.g Draganska, Mazzeo, andSeim, 2009 andFan, 2013).…”