CROSS-BORDER MERGERS
AS INSTRUMENTS OF
COMPARATIVE ADVANTAGE
J. Peter Neary
University College Dublin and CEPR
www.ucd.ie/~economic/staff/pneary/neary.htm
2
5. Cross-Border Mergers and Acquisitions
So far: Greenfield FDI only
BUT: Cross-border M&As are quantitatively much more important
Now: Oligopoly model essential (almost) • No: Barba Navaretti/Venables (2003), Nocke/Yeaple (2004), Head/Ries (2005)
• Yes: Long/Vousden (RIE 1995), Falvey (WE 1998), Horn/Persson (JIE 2001), etc.
• Here: Neary (2004)
Model of 2-country integrated market:• Cournot oligopoly
• Home: n firms with cost c; Foreign: n* with cost c*
• Absent mergers: “Cone of diversification” in {c, c*} space
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Cross-border mergers:• M&A’s a huge % of all FDI: more than greenfield FDI
• A high % of mergers are cross-border
• Cross-border merger waves linked to market integration[EU Single Market; Mercosur]
How to explain them?• I.O.:
• Strategic and efficiency motives
• All partial equilibrium
• Macro: Major innovationsJovanovic/Rousseau (2003)
• International Trade Theory: • Dominant paradigms: Competition (perfect/monopolistic)
• Needed: Oligopoly in GE
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Plan
1. Specialisation Patterns in the Absence of Mergers
2. Myopic Mergers
3. Forward-Looking Mergers
4. General Oligopolistic Equilibrium:• Factor and Goods Markets: Ricardo + Cournot
• Demand: Continuum-Quadratic Preferences
5. Mergers in General Equilibrium
6. Mergers and Welfare
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1. Specialisation Patterns Without Mergers
• Consider a typical sector, in partial equilibrium• Homogeneous-good Cournot competition• 2 countries, integrated world market• Perceived linear demands: p = a - b x• Given numbers of firms at home & abroad: n, n*• Firms in each country have identical costs: c, c*• Equilibrium home sales:
n c a* ' 0 10
• Also holds with no foreign firms:
ya n c n c
b n n
' ( )
' ( )
* * *
*
1
1
c a c 0 01' ( ) *ca n c
n
' * *
* 1
• So: y>0
10
Equilibrium Production Patternsfor Arbitrary Home and Foreign Costs
c
c*
HF: Homeand foreignproduction
O: No home orforeign production
F: Foreign production only
H: Homeproduction only
a '
a '
a
n
'
1
a
n
'* 1
11
Fig. 4: Equilibrium Production Patternsin Free Trade without FDI
c O: No home orforeign production
~c
F: Foreign production only
H: Homeproduction only
c*
HF: Homeand foreignproduction
~*c
(c,c*;n,n*)=0
*(c,c*;n,n*)=0
12
c
c*
O: No home orforeign production
F: Foreign production only
H: Homeproduction only
Compare with perfect competition:
a '
a '
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2. Myopic Mergers
Assumption 1: Only bilateral mergers can occur.
Immediate gain from a merger:
Assumption 2: A merger will not take place if GFH is zero or negative.
Assumption 3: A merger will take place if GFH is strictly positive.
G n n n n n n n nFH ( , ) ( , ) ( , ) ( , )* * * * * * 1
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What are the incentives to merge?• No incentive if all firms are identical (and n+n*>2)
[Salant, Switzer, Reynolds (QJE 1983): “Cournot merger paradox”]
• Nor if the 2 merging firms are identical (and n+n*>2)[Proposition 1]
• Intuition:
• i.e., the profits of the acquiring firm would have to double for such a merger to be profitable
• Same for all firms like the acquiring firm
Myopic Mergers (cont.)
G n n n n n nHH ( , ) ( , ) ( , )* * * 1 2
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• BUT: Outputs are strategic substitutes
Myopic Mergers (cont.)
• Removing a rival shifts down the reaction functions of all others
• Movement along own reac. func.
• So: Outputs and operating profits rise for all surviving firms (including the acquiring firm)
• Hence: If firms differ in cost, a low-cost/high-cost takeover may be profitable
yF
y F
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Proposition 2: If c>c*, a takeover by a foreign firm is profitable if the home firm has sufficiently high costs:
GFH>0 IFF:
Proof:
c a c 1 1 1 01 0' ( ) *
G y y yFH ( ) ( )* *1
20
202
( )( )* * * *y y y y y1 0 1 0 02
Lemma y y yn: * *1 0
10
10 1 0 0n y y y ny( )* *
c a c 1 11' ( ) *
1
2
2
2 1 2 1
2 1
( ) /
( ) ( )
( )
*n n n n n
n n 0
19
a–c
Fig. 5: The Components of Gainfrom a Cross-Border Acquisition by a Foreign Firm
*
Q R a–c*
GFH < 0
GFH > 0
20
OFc
c*
HF
H
Incentives for foreign firms totake over home
Incentives for home firms to
take over foreign
Similarly, GHF >0 IFF: c a c* * *' ( ) 1 11
1* 'a
Fig. 2: Takeover Incentives
1 a'
0a'
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Fig. 6: Cross-Border Merger Incentives
Incentives for home firms to
take over foreign
c
c*
H
OF
HF
Incentives for foreign firms totake over home
=0
GFH=0
GHF=0
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Effects of one takeover on incentives for more?• All surviving firms have higher output and profits:
y y* > 0• Low-cost firms have higher output to begin with• So, their profits rise by more: GFH is decreasing in n
[Proposition 3]
• i.e., “Merger Waves” / “Domino Mergers”: =>• No high-cost firms survive• Mergers may not take place if n is large, even though
further mergers would be profitable• Encouraging “national champions” by promoting
domestic mergers in high-cost sectors makes foreign takeovers more likely (in the absence of cost synergies)
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5. Cross-Border Mergers and Acquisitions (cont.)
Merger gains:• For an acquisition of a home by a foreign firm:
GFH(c, c*; n, n*) = *(.) (.)
• Always negative between identical firmsSalant/Switzer/Reynolds (QJE 1983) “Cournot merger paradox”
• Positive for a sufficiently large cost advantage
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5. Cross-Border Mergers and Acquisitions (cont.)
So: Autarky to free trade encourages cross-border M&As
Further results:
• GFH decreasing in n: Merger waves
• GFH decreasing in t (definitely for high t)So partial trade liberalisation encourages cross-border M&As
Empirical evidence: • Brakman/Garretsen/van Marrewijk (2005): Evidence in
favour of comparative advantage and merger waves
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• Continuum of sectors, indexed z [0,1]• Ricardian cost structure:
c(z) = wz),
c*(z) = w*z)• Assume home more efficient in low-z sectors• 2 threshold sectors
[Perfect competition: c(z)=c*(z) is the threshold for specialisation]
4. General Oligopolistic Equilibrium
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Fig. 1: Equilibrium Production Patternsfor a Given Cost Distribution
c
c*
Foreign production only
Home and foreign
production
Homeproduction only
O
c*(0)
z z~
z 0
z 1
z z~*
c*(1)
c(0)
c(1)
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Demand
“Continuum-quadratic” preferences:
Max U x z ax z bx z dz[{ ( )}] [ ( ) ( ) ] 12
2
0
1
subject to: ( ) ( )p z x z dz I0
1
p z a bx za bIp
p
( ) [ ( )],12
• Objective demand functions: depend on income and all prices
• Summing over 2 countries => Linear subjective demand funcs:
p z a b x z a a a b b( ) ' ' ( ), ' ( ) / , ' / ,* *
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GOLE: The Full Model
Three nominal variables: w, w*,• Absolute values are indeterminate• Convenient normalisation: W=w, W*=w*
Full employment:
y z W W z(~, , ) , ~* 0 1
y z W W z* * * *(~ , , ) , ~ 0 0
Threshold sectors:
L L W W z ( , , ~)*
L L W W z* * * *( , , ~ )
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Assume symmetric countries:• n=n*, L=L*, etc. => W=W*Wage adjustment:• Expanding and contracting firms in both• BUT: High-cost firms contract by more• So: Demand for labour falls• Wages fall, dampening merger incentives
Threshold sectors:
5. Mergers in General Equilibrium
G W z W z a W z( ,~; ) (~) ( ) (~)*
1 0
Labour-market equilibrium:L L W z
( , ~ )
( )
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Fig. 3a: Simultaneous Determination of Wages and Threshold Sectors: The No-Mergers Equilibrium
W
L=L(.)
G(.; )0 0
~z 1½
G W z( ,~; )
0
L L W z
( , ~ )( )
~z0
W0
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G W z( , ~; )
0
L L W z
( , ~ )( )
Fig. 3: Simultaneous Determination of Wages and Threshold Sectors
W
~z 1½
G(.; )0 0
G(.; )1 0G(.; )2 0
L=L(.)
~z0
W0
~z1~z2
W1
W2
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Partial-equilibrium intuition: W = CS + [Only changes in sectors where mergers occur matter]
1. Less competition Some prices CS 2. High-cost firms are eliminated
2. Dominates [Lahiri-Ono EJ 1988]
GE: Consumers are also profit recipients[Welfare is just the consumer’s (indirect) utility function]
1a. At given wages, only effect 1. matters U 2a. W all prices U
So: Full effect ambiguous in GE, but for different reasons from partial equilibrium
6. Mergers and Welfare
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~( )U a p 2 2
12
2 2 21
12
0 p
z
zp W z n n dz p W z n dz ( , ; , ) ( , ; , )*
~*
~
p W z n na nW z n W z
n nand p W z n
a n W z
n( , ; , )
( ) ( )( , ; , )
( )** *
**
* *
*
1
01
12
2
2 20d
dzp W z n n p W z n
p~ ( , ; , ) ( , ; , )* *
p W z n n p W z n( , ; , ) ( , ; , )* *0
b n
ny W z n n IFF y
'( , ; , ) (.)*
*
10 0
So: ~ ~( , ~ )
( )U U W z
At given wages, mergers (z~ ) raise prices in all sectors:
Mergers and Welfare (cont.)
Indirect utility:
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G W z( , ~; )
0
L L W z
( , ~ )( )
Fig. 5a: Mergers Increase Welfare
W
~z 1½
G(.; )0 0G(.; )1 0
G(.; )2 0
~( , ~ )
( )U U W z
E0
E2
E1
~(.)U U
L=L(.)
37
G W z( , ~; )
0
L L W z
( , ~ )( )
Fig. 5b: Mergers Reduce Welfare
W
~z 1½
G(.; )0 0G(.; )1 0
G(.; )2 0
~( , ~ )
( )U U W z
E0
E2
E1
~(.)U U
L=L(.)
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Conclusion
Cross-border mergers are “instruments of comparative advantage”:
• More specialisation• Welfare may rise
Despite:• Reduced competition in many sectors• Redistribution from wages to profits
Empirical predictions: • Trade liberalisation increases FDI• Absent cost synergies, low-cost firms acquire high-
cost foreign rivals• FDI & trade are complements
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