In new research, Semih Üslü and Flavien Moreau argue that waves of mergers and acquisition, which are typically unstable and ultimately crash, are not driven by changes in economic conditions, but by self-reinforcing appetite for mergers among firms when others are also engaging in M&A. Policies that drive stable, low-merger conditions can lead to better outcomes for consumers.
Disclaimer: The views expressed in this article are those of the authors and do not represent the views of the IMF, its Executive Board, or IMF management.
Every decade or so, merger activity surges in the United States. Deals multiply, firms’ valuations climb, and acquisition announcements follow one another in rapid succession. Then, often within a few years, the wave breaks—not gradually, but abruptly. For example, in the late 1990s, there was a wave of cross-border mergers in the telecommunications and media industries, which ended in the stock market crash known as the“dot-com bust.” Similarly, the mid-2000s banking and telecommunications merger wave collapsed with the 2008 financial crisis. In each case, economists later emphasize proximate causes that may have precipitated the crash: credit tightened, regulation toughened, and the economic outlook darkened.
In a forthcoming paper, “A Search-Based Theory of Merger Waves”, we argue that external shocks do not alone drive these collapses, nor do fundamentals. Rather, what encourages a wave of mergers and then its recession is a collective shift in firms reallocating resources to and from engaging in mergers and acquisitions (M&As), which grows and shrinks the potential pool of firms actively seeking to merge.
In a model of how firms choose between growing through acquisitions and growing through internal research and development, we find that the same wider economic environment can sustain two very different equilibria: one in which merger activity is limited and stable, and one in which it is elevated and fragile. Merger waves, on this account, are not merely the economy’s rational response to improving conditions. They are episodes of coordination—and like all coordination equilibria, they can unravel suddenly.
When searching for a target makes others search too
To understand why merger waves unravel, it helps to think carefully about what acquiring a firm actually involves. Finding a suitable firm to acquire takes time and resources. Firms devote resources to scouting, due diligence, and maintaining relationships with investment banks and potential partners. This search process is not passive. How quickly a firm finds its match depends on the intensity with which it searches for its target.
Now consider what happens when the pool of potential acquisition targets improves in size and quality. This happens when other firms are also looking to merge organizations, as mergers tend to combine and upgrade productive capabilities as well as pricing power. A more attractive pool of firms seeking to merge raises the expected payoff from searching, which in turn gives any individual firm a stronger incentive to search intensively. This is a strategic complementarity: when others search more, you want to search more, too.
Strategic complementarities of this kind often lead to situations where there is more than one possible outcome depending on the expectations of others, known in economics as multiple equilibria. For example, in banking, customers might suddenly decide to all withdraw their money at the same time out of fear that their bank won’t be able to pay them back their deposits, causing the bank to collapse. On the other hand, if people believe a bank is safe, they might deposit or leave their money alone, which keeps the bank functioning. Both options are viable—they depend on what people believe. The same thing can happen if investors anticipate a currency to lose value, act accordingly, and then unintentionally create a currency crisis. The alternative is a stable currency driven by normal investment.
Our paper shows that the same logic applies to corporate M&A. In our framework, firms allocate a fixed budget between acquisition search and internal R&D. When other firms allocate heavily toward acquisitions, the quality of the target pool rises, which makes acquisitions more attractive, reinforcing the allocation toward acquisitions. The economy can get stuck in a high-M&A regime sustained not by permanently better fundamentals, but by self-fulfilling expectations.
Two equilibria, one economy
The model offers two possible alternatives. In the first—the stable one—firms devote a relatively modest share of resources to M&A search and a correspondingly larger share to in-house R&D. In the second—the unstable one—firms allocate heavily toward acquisitions and away from innovation.
In the stable scenario, when only a few firms are pursuing M&As, the market remains steady and small changes to the number of firms actively searching don’t have a large effect on other firms. The unstable alternative occurs when a high number of firms are seeking out M&As, which is sustained only as long as firms expect other firms to look to acquire or be acquired. Any disruption—tighter credit, a high-profile M&A deal that falls apart, a shift in antitrust enforcement—can break the consensus and send the economy back to the stable equilibrium option. This provides a natural account of why merger waves end abruptly: not because the underlying shock is large, but because the high-merger equilibrium is unstable and always one step away from collapse.
This framework also provides a new lens on how merger waves begin. A favorable shift in fundamentals—cheaper financing, regulatory permissiveness, a new wave of technological complementarities—does not need to be large. It needs only to move the economy into the region where the high-merger equilibrium becomes viable, at which point the arrival of an event to coordinate expectations, such as a few high-profile deals that signal the market is open for business, can catalyze a transition. In this reading, the clustering of deals that characterize merger waves are not incidental but structural: they are the visible face of a coordination process.
Historical evidence is consistent with this interpretation. The Great Merger Wave, which began at the end of the nineteenth century in the U.S., lasted roughly a decade before collapsing. The collapse wasn’t driven by the economy deteriorating dramatically, but partly because stronger enforcement of the Sherman Antitrust Act raised the costs of completing deals and eliminated the high-merger equilibrium altogether. The merger wave of the mid-1980s has similarly been linked to relatively permissive state-level antitrust regulation, which kept the cost of acquisitions low enough to sustain elevated activity. When that regulatory environment tightened, the wave ended.
The surprising consumer welfare arithmetic
What does this mean for consumer welfare? The answer is less obvious than it might appear.
In our calibrated model, the stable low-M&A equilibrium is not only more sustainable—it is also better for consumers. Firms invest more of their resources in R&D rather than acquisitions, so average product quality is higher. Markups are higher too, but for a reason that matters: when products are better, customers are willing to pay more for them, and firms have more to gain from strengthening their bargaining position. The same R&D that improves products also makes those products more profitable to sell at a premium. Consumers still come out ahead, because the gain in quality outweighs the higher prices. The broader lesson is that markups alone can be a misleading guide to welfare. The equilibrium with higher markups is also the one with better products, higher consumer surplus, and higher social welfare. Meanwhile, the high-M&A equilibrium features greater concentration but lower average markups, precisely because firms invest less in improving their products.
Even in the stable equilibrium, private firms overinvest in acquisitions. The reason is precisely the strategic complementarity: because each firm’s acquisition activity improves the target pool for others, firms collectively over-allocate toward M&A and under-allocate toward R&D. Ideally, consumer welfare would benefit from firms choosing roughly half the current merger activity and substantially more R&D than the market delivers.
Policy implications
The policy implications are nuanced. First the high-M&A equilibrium harms consumer welfare. Permissive antitrust policy that keeps acquisition costs low does not simply free efficient markets to reallocate resources. It can also enable a fragile, coordination-driven merger wave that crowds out R&D and can leave the economy worse off.
Our model supports tighter merger enforcement as most beneficial to social welfare, but with an important qualification. Stricter antitrust policy, by raising the cost of completing acquisitions, reduces equilibrium merger activity in the stable regime and can eliminate the high-merger equilibrium altogether. This is unambiguously welfare-improving in our framework. But because of strategic complementarities, stricter enforcement has the counterintuitive effect of raising the M&A intensity in the unstable, high-merger equilibrium, not reducing it. The unstable equilibrium, if it were to be reached, would require even more intense coordination to be sustained. This creates a delicate policy landscape: before eliminating the unstable equilibrium entirely, tighter enforcement could first create a final burst of M&A activity by increasing the private costs of searching, potentially inspiring all firms to search more intensely until the benefits inevitably fall and firms reduce their search intensity.
There is a third implication that tends to get less attention in antitrust debates: the role of innovation policy. Our model shows that R&D subsidies or tax credits—by making internal growth more attractive relative to acquisitions—can reduce the chances of a high-merger equilibrium. In other words, innovation policy is also merger policy. A government that subsidizes R&D is, indirectly, making sustained merger waves less likely. This complementarity between antitrust enforcement and innovation support deserves more attention than it typically receives.
Authors’ Disclosures: The authors report no conflicts of interest. You can read our disclosure policy here.
Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.
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