Scandinavian Working Papers in Economics

Working Paper Series,
Research Institute of Industrial Economics

No 511: Why Mergers Reduce Profits, and Raise Share Prices

Sven-Olof Fridolfsson () and Johan Stennek
Additional contact information
Sven-Olof Fridolfsson: The Research Institute of Industrial Economics, Postal: Box 5501, SE-114 85 Stockholm, Sweden
Johan Stennek: The Research Institute of Industrial Economics, Postal: Box 5501, SE-114 85 Stockholm, Sweden

Abstract: We demonstrate a "preemptive merger mechanism" which may explain the empirical puzzle why mergers reduce profits, and raise share prices. A merger may confer strong negative externalilties on the firms outside the merger. If being an "insider" is better than being an "outsider", firms may merge to preempt their partner merging with someone else. Furthermore, the pre-merger value of a merging firm is low, since it reflects the risk of becoming an outsider. These results are derived in a model of endogenous mergers which predicts the conditions under which a merger occurs, when it occurs, and how the surplus is divided.

Keywords: Mergers & acquisitions; definsive merger; coalition formation; antitrust policy

JEL-codes: C78; G34; L13

41 pages, First version: March 12, 1999. Revised: December 3, 2001.

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