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How mergers affect innovation…maybe?

How mergers affect innovation…maybe? published on

Justus Haucap and Joel Stiebale with the Düsseldorf Institute for Competition Economics (DICE) at the University of Düsseldorf have a recent paper analyzing the effects of mergers on innovation in the European pharmaceutical industry. The develop a model that suggests mergers reduce innovation not only in the merged firms, but among industry competitors as well. Their data bear this out, as explained in the abstract:

This papers analyses how horizontal mergers affect innovation activities of the merged entity and its non-merging competitors. We develop an oligopoly model with heterogeneous firms to derive empirically testable implications. Our model predicts that a merger is more likely to be profitable in an innovation intensive industry. For a high degree of firm heterogeneity, a merger reduces innovation of both the merged entity and non-merging competitors in an industry with high R&D intensity. Using data on horizontal mergers among pharmaceutical firms in Europe, we find that our empirical results are consistent with many predictions of the theoretical model. Our main result is that after a merger, patenting and R&D of the merged entity and its non-merging rivals declines substantially. The effects are concentrated in markets with high innovation intensity and a high degree of rm heterogeneity. The results are robust towards alternative specifications, using an instrumental variable strategy, and applying a propensity score matching estimator.

While I haven’t yet read the paper in detail, a cursory examination suggests they have ignored another possibility: mergers in high-intensity R&D industries could be a leading indicator of decreased innovation productivity (i.e., lower returns to investment in R&D). Consider that as research advances, the “low hanging fruit” are collected first before the more difficult (and lower return) investments are pursued. As companies in a high-intensity R&D industry exploit all of the low hanging fruit, particularly internally, one might expect mergers as a way of expanding the available set of lower-cost/higher-return R&D investment opportunities. Since firms are competing in the same science space, a slow-down in one firm is likely to be spuriously correlated with slowdowns throughout the industry.

“Affect” is a word of causation. To suggest that mergers cause a reduction in innovation is a strong statement–especially when paired with a merger policy implication. This may be something that bears more scrutiny since, as the authors note, the entire subject is one on which relatively little light has thus far been shed.

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