Horizontal mergers and exit in declining industries

Abstract

Previous work on exit in declining industries has neglected mergers. This paper examines a simple model that illustrates how mergers can affect the order of exit. The model also predicts which declining industries experience horizontal mergers. Mergers are more likely if (1) the inverse demand curve is steep at high levels of output and flat at low levels of output; (2) the industry declines slowly early on and rapidly later on; and (3) market concentration is high. The conditions that make mergers privately profitable also tend to make them socially optimal.

Acknowledgements

We thank Bill Brown and Janet Smith for comments and Ozan Sula for research assistance.

Notes

One exception to the general neglect of mergers in models of firm behaviour in declining industries is Dutz (1989). Empirical work on declining industries has also neglected mergers (Baden-Fuller, 1989; Lieberman, 1990; Deily, 1991). One exception is Schary (1991).

There is another reason why merging tends to be socially desirable in this model: a merger is profitable only if the small firm's capacity is less than the initial monopoly quantity; otherwise the small firm is more profitable than the large firm in every period. Therefore, the large firm buys the small firm only when the small firm would under-produce relative to the social optimum early on in the declining period.