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Blog Paul de Bijl: Empirical findings on mergers and innovation

This fall, the European Commission will put the finishing touches on the new EU merger guidelines , which also affect ACM’s work. The main objectives of the review are to have merger assessments better align with economic developments, as well as to enhance Europe’s competitiveness and strategic autonomy. That fits in with Mario Draghi’s call in his 2024 report to give more attention to innovation and investments in European merger assessments.

This review has already generated much debate. And rightly so, for it is an important debate to have, one where the Commission has indicated to be open to considering the broader context in merger assessments (within the boundaries of the unaltered EU Merger Regulation). A point of criticism was that negative price effects in the short term were dominating. Yet, mergers can also lead to positive ‘dynamic effects’ such as innovation, investment, and market entry. And yes, also to negative dynamic effects, such as market exclusion and impediments to innovation. Due care is therefore key. What makes it difficult is that assessing dynamic effects (and taking these into account) requires foresight. Scientific insights into the impact of mergers come in handy in that regard, such as two studies that the European Commission (DG Competition) had had commissioned for this purpose.

Theory and empirical findings

How does market concentration relate to innovation? Since a merger reduces the number of competitors (and possibly also competition itself), there is a parallel with the relationship between competition and innovation. This can go anywhere. Economists describe this as an inverted-U: first, competition pushes businesses to innovate. Yet, when risky R&D is hindered by fierce competition, it can work as a brake. With the many different possibilities around, it helps to have a framework ready that sorts the possible effects.

The first study for the Commission, conducted by consulting firm Oxera and several academic experts, presents a framework for interpreting the impact of mergers on expected (future) consumer welfare (report in two parts, see part 1 and part 2 ). In broad strokes, the following dynamic effects can occur:

  • Positive effects: After a merger, more of the profits from successful innovations will stay within the group. Also, any knowledge gained that could otherwise have leaked to a competitor (the planned merger partner) will stay within the merged company. That makes it more appealing to innovate (although knowledge can still leak, which reduces the incentive to innovate). Mergers may also create synergies, for example, because of complementarity and economies of scale. Non-horizontal mergers can yield efficiency gains, and eliminate double mark-ups. Furthermore, the prospect of acquisition is appealing to startups.
  • Negative effects: a horizontal merger eliminates (future) competition on price, quality, and innovation between merger partners. Even when that prospect elicits more investments, prices are expected to go up, and consumers will have less choice. In addition, competition on innovation can decrease, due to weaker incentives to stay ahead and gain market share from competitors (such as the planned merger partner). Non-horizontal mergers create a risk of reduced access to inputs, which hinders competitors and raises their costs. In addition, mergers that raise entry and exit barriers make dominant players even stronger.

Benefits that can compensate the drawbacks must, according to an assessment framework in the report, be verifiable and merger-specific, and work out favorably for consumers, which is in line with the usual checks in an efficiency defense. If the costs are greater and are expected to occur sooner, the benefits must be greater and more plausible (which can also go the other way).

The report also discusses the current state of play in the academic literature on competition, mergers, and innovation. A fragmented picture is painted, which shows that the effects are ambiguous. Empirical studies do show that competition makes companies more productive, and leads to replacement of less-productive companies by more-productive ones.

The second study for the review of the merger guidelines was conducted by scholars Joel Stiebale and Florian Szücs. They conducted an ex-post evaluation of 3,825 mergers, assessed by the European Commission between 1990 and 2024. Where the first report discusses 475 studies on all kinds of possible dynamic effects, this second study is a sharply defined empirical study using targeted data. This study paints an unfavorable picture: the cleared mergers led, on average, to fewer patents and higher profit margins, both for the merger parties and for their competitors. Apparently in practice, concentration mostly leads to, on average, more market power and less competition and innovation. These empirical findings contrast with the promises made in connection with planned mergers and acquisitions, and also with the claim that European merger control is too strict, as suggested by the Draghi report. From an innovation and investment perspective, European merger control was rather too lenient. Moreover, there is little evidence that mergers have led to more innovation in strategically important technology domains. A side note on this study is that the researchers used the number of patents for measuring innovation. That is a common proxy, but it’s not the only way in which innovation materializes.

Also, the review of the merger guidelines elicits research in other ways too. Where the Draghi report argued in favor of more market concentration specifically for telecom, also on national markets, a recent study actually points out that healthy market dynamics do not call for that. Also, European merger control does not stand in the way of cross-border scaleups in the telecom sector.

Balanced assessments

Why do CEOs love mergers so much? Sure, shareholders benefit from increased profitability when competition is reduced, and companies and their CEOs can then enjoy the proverbial ‘quiet lives’. However, in some cases, there can definitely be justified prospects of innovation and synergy effects that benefit buyers, while creating value for shareholders. Still, such benefits are often overestimated: CEOs sometimes place too much faith in their own visions (managerial hubris theory). And, in some instances, they mostly want to build empires, even though that is not in the interest of their shareholders (agency theory).

To outsiders, including competition authorities, the ´true´ motives for a merger or acquisition are difficult to assess. That doesn´t really matter though. What counts are the expected positive and negative effects. Competition authorities are open to be persuaded by positive effects that are expected to occur only later. The clearer the need or necessity of a merger plan, the easier it is to substantiate it. Due to the importance of competition to innovation and resilience, well-founded assessments are all the more important.

See also