How Mergers Affect Innovation: Theory and Evidence for the Pharmaceutical Industry

We analyse how horizontal mergers affect the incentives for product innovation in a cournot model with heterogeneous firms. We find that a merger is more likely to be profitable in an industry with a high research intensity. For a high degree of firm heterogeneity a merger reduces innovation in both the merged entity and in non-merging competitors when innovation costs are low. Using data on horizontal mergers in the pharmaceutical industry in Europe, we find that our econometric results are consistent with many predictions of the theoretical model. Our main results show that after a merger patenting and R&D decline both in the merged entity and among non-merging competitors. The results are robust towards alternative specifications and using an instrumental variable strategy.