Are Larger Merger Synergies Bad News for Consumers? Endogenous Post‐Merger Internal Organization

• DOI: http://doi.org/10.1111/sjoe.12303
• Author: Duarte Brito,Margarida Catalão‐Lopes
• Published date: 01 October 2019
• Date: 01 October 2019

Scand. J. of Economics 121(4), 1728–1756, 2019

DOI: 10.1111/sjoe.12303

Are Larger Merger Synergies Bad News for

Consumers? Endogenous Post-Merger

Internal Organization*

Duarte Brito†

Universidade Novade Lisboa, 2829-516 Caparica, Portugal

dmb@fct.unl.pt

Margarida Catal˜ao-Lopes‡

Universidade de Lisboa, 1049-001 Lisboa, Portugal

mcatalao@tecnico.ulisboa.pt

Abstract

In this paper, we endogenize the post-merger internal organization of firms, considering two

alternative structures: multidivisional, in which separate divisions are kept, and traditional, with

cost synergies. Weanalyze when each structure occurs in equilibrium and how it affects welfare.

Weshow that higher synergies do not necessarily lead to higher consumer surplus: firms can opt

for a merger type that does not increase consumer surplus as much as the one that would occur

with lowersynergies. This highlights the importance of antitrust authorities basing their decisions

not just on the magnitude of eventual synergies but also on the post-merger organizationalfor m.

Keywords: Endogenous firm structure; mergers and acquisitions; multidivisional firms

JEL classification:L13; L22; L41

I. Introduction

The creation of divisions within a firm that results from a merger is an

interesting possibility. By keeping its divisions independent, and providing

its managers with the adequate incentives, the firm that results from the

merger can make full use of its structure to obtain a strategic advantage

over its rivals. Examples of firms operating several divisions are relatively

common in the hotel industry, in the tobacco market, in the matches market,

in the beer market, in the automobile industry, in broadcasting, in the airline

industry, and in the tissue market, among others.

This multidivisional form contrasts with the traditional full integration of

the merging parties. By keeping separate divisions in operation, the merged

*D. Brito acknowledges financial support from Funda¸c˜aoparaaCiˆencia e a Tecnologia and

FEDER/COMPETE (UID/ECO/04007/2013).

†Faculdade de Ciˆencias e Tecnologia.Also affiliated with CEFAGE-UE.

‡CEG-IST, Instituto Superior T´ecnico.

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The editors of The Scandinavian Journal of Economics 2018.

D. Brito and M. Catal˜ao-Lopes 1729

firm might be unable to obtain some cost savings or synergies that are

usually associated with mergers. Farrell and Shapiro (2001) call synergies

the efficiencies that cannot be obtained unilaterally as they “require intimate

integration of the parties’ unique, hard-to-trade assets”, which can be harder

to obtain when divisions operate independently. Huck et al. (2004) also

mention that “[i]n contrast [to firms remaining as independent decision-

making units], cost advantages and increasing returns may suggest a fusion

of the merging firms to a single unit of production and decision-making.”

Thus, it is reasonable to assume that cost reductions or synergies are, at least

partially, foregone if the merged firm decides to operate several independent

divisions.

This means that, under some circumstances, the owners of a merged

firm face a trade-off and must make a choice: to operate as a single firm,

benefitting from some cost savings (traditional merger), or to operate with

several independent divisions (multidivisional merger). At the expense of

cost savings, the latter type of merger enables an internal organization

structure that increases the set of strategies available to the firm, providing

it with a different type of advantage with respect to its rivals.

In this paper, we make this decision endogenous: firms choose the post-

merger internal organization that yields the highest post-merger profit, from

the set of those that would be approved by a competition authority. In terms

of set-up, we assume that firms sell a homogeneous product and compete

in a Cournot way with constant marginal costs. As for mergers, we bring

together two alternative ways of modeling mergers that we borrow from

the literature discussed in the following section.

In addition to characterizing when each type of merger will take place

and how it will affect welfare, we also obtain some interesting results.

We show that the existence of higher potential cost synergies does not

necessarily imply higher consumer surplus in equilibrium. In the presence

of only one type of merger, this would be impossible. However, by allowing

for different types of mergers, higher cost savings might make firms choose

a different type of merger (the “wrong” type of merger in the consumers’

perspective), which does not increase consumer surplus as much as the one

that would be proposed under lower cost savings. In other words, firms

choose traditional mergers too often, which is inefficient, and the policy

recommendation that can be derived from this result is that authorities

that follow a consumer surplus standard should be more demanding in

terms of the magnitude of cost savings required for traditional merger

approval, when multidivisional mergers are deemed possible. Otherwise,

their decisions can lead to suboptimal results in terms of consumer surplus.

The intuition for this new insight for merger policy is simple. In our setting,

the multidivisional merger is more profitable and yields a higher consumer

surplus than the alternative traditional merger, provided that synergies are

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The editors of The Scandinavian Journal of Economics 2018.