Brooke Fox and Walter Frick analyze research and ideas presented at the 2023 Stigler Center Antitrust and Competition Conference from scholars like Oliver Hart, Sanjukta Paul, Tommaso Valletti that question the value of mergers and ask: how would businesses react to a world with fewer mergers?

What strategies would businesses pursue if they knew they were not allowed to buy their competition? How might they choose to hire and invest and innovate if mergers were the exception rather than the rule?

Sanjukta Paul, a professor at the University of Michigan law school, raised this question at the Stigler Center Antitrust and Competition Conference in April. It was meant as a thought experiment, not a policy proposal, and it’s worth taking seriously. Mergers, as Paul outlined, are a legal exemption from competition. The law allows two firms to join together on the assumption that they will be more productive in combination than they were on their own. The question Paul was raising in her hypothetical was a simple one: How often is that actually true? How often do mergers actually boost firms’ technical productivity, versus simply giving them greater market power with which to extract rents?

The answer to that question comes from another presentation from the same conference. John Kwoka, an economist at Northeastern University, conducted a meta-analysis of 60 merger retrospectives and concluded that 83% resulted in price increases. In other words, about four of every five mergers in the dataset turned out poorly for consumers upon subsequent analysis. Of course, the outcome of a merger depends on how many competitors are left in a market: If two firms merge in a market with a dozen competitors, that might not be so bad; if two firms merge in a market with four competitors that seems a lot more worrisome. Kwoka found that all of the mergers in his dataset that left five or fewer competitors in the market led to higher prices. Among mergers that left seven competitors, half led to higher prices.

The upshot from Kwoka’s work is that for any market with only a handful of companies, it’s a good bet that a merger will turn out badly for consumers. Kwoka is not the only scholar to reach this conclusion. In a 2016 paper, researchers at the Federal Reserve and the University of Oregon looked at mergers of US manufacturing plants between 1997 and 2007. In an article for Harvard Business Review, they summarized their findings:

“We find that mergers do not have a discernible effect on productivity and efficiency. Specifically, we do not find evidence for plant-level productivity changes, nor do we find evidence for the consolidation of administrative activities that is often cited as a way in which mergers yield lower costs through economies of scale. We also don’t find evidence that merged firms are more likely to close down less-efficient plants. By contrast, we find substantial average increases in the amount that firms mark up prices over cost following a merger, ranging from 15% to over 50%, depending on the control group we use.”

A 2023 paper by Filippo Lancieri, Eric A. Posner, and Luigi Zingales reviewed the literature on mergers and concluded that merger studies almost uniformly find that mergers have resulted in higher prices and/or assume too high efficiencies as a result of the merger.

It’s worth putting these results in the context of Paul’s framing. We allow mergers—a legal exemption from competition—because we expect that it will make firms more technically proficient and thereby make the economy more productive. But the data we have on mergers suggests this may not be the typical outcome: Mergers are often a way of consolidating market power. And the work of the Nobel Prize-winning economist Oliver Hart helps to explain why that is.

Theories and History

In a recent interview with ProMarket at the Stigler antitrust conference, Hart–whose Nobel Prize was on incomplete contracts and the theory of the firm–explained how his work on contract theory relates to merger enforcement. Economists typically assume that mergers produce efficiencies. But Hart thinks such theories lack a strong foundation. 

“My view currently is that it’s just not clear why two companies need to merge in order to achieve efficiencies,” he told ProMarket. “I think they could often do it in another way.”  The ‘other way’ that Hart is referring to is by contract. In other words, Hart is asking: What efficiencies are achieved via merger that cannot be achieved via contract?  “And so perhaps we should be more suspicious of mergers than we have been,” Hart concluded.

Stick with Paul’s thought experiment for a little while longer: What would firms do in a world where it was much harder to merge? Big firms could still exist but they would need to make their own products rather than buy other firms to enhance market power. This would have mixed effects on innovation. Companies would likely invest more in their own research and development. Startups would lose the often lucrative option of selling to larger firms, but research by economist Florian Ederer suggests that even they might be better off—because dominant firms would have to compete with them through innovation rather than acquisition. Ederer’s work with colleagues shows that acquisitions are often not made to foster new products, but to ensure that the startup will not one day compete with the incumbent firm. He calls this a ‘killer acquisition.’

Of course, for all the theory and data casting doubt on mergers, there are clearly mergers that make sense. Imagine two freelancers deciding to join forces and start a company—the benefits of coordination could be real, even given the existence of contracts, and no one could argue that the new two-person firm possessed excessive market power. 

“There are going to be some cases which are quite benign and there’s no serious anti-competitive concern,” Hart said. “Probably many of them wouldn’t even come to the attention of the antitrust authorities. So yeah, it would be going too far to say we ban all mergers.” 

Likely, there will not ever be a world without business mergers, nor should there be. The problem stems from the size of firms merging. As economist Tommaso Valletti proposes: If you’re big you should have to “make” not “buy.” In other words, mergers involving large firms would carry the presumption of anticompetitive effects—to approve a transaction, firms would have to prove that it would actually increase welfare.

Valletti, along with Fillippo Lancieri, lays out the case for such a policy in a piece for ProMarket. The practical nature of the proposal is that, rather than trying to  “undo the abuses of market power, you may try to prevent market power from arising,” Valletti said.

This proposal—which Kwoka has also argued for—does not put a cap on how large firms can become, as long as the growth comes organically and not from the purchase of a competitor (with some exceptions). And it has a long history in antitrust economics, as Chicago Law professor Eric Posner noted in his conference presentation. He pointed out that Nobel Laureate and Berkeley economist Oliver Williamson, in the same paper that is part of the foundation for evaluating efficiency of a merger, posits many qualifications including the idea that perhaps the 100 largest firms should not be allowed to merge.

“The intention of Congress, clearly embodied in the statute, was to go after declining competition caused by mergers because of the general social and political effects which have been a huge part of American history since the very beginning,” Posner said, emphasis ours.

A presumptive ban on mergers by large firms is a way of taking Paul’s initial provocation seriously: How might companies conduct themselves in a world where they could not merge? The hope is that they would rise to the challenge and contract where necessary, compete through investment, and grow through innovation.

Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.