Does the Potential to Merge Reduce Competition?

We study anticompetitive horizontal mergers in a dynamic model with noisy collusion. At each instant, firms either privately choose output levels or merge to form a monopoly, trading off the benefits of avoiding price wars against the costs of merging. The potential to merge decreases pre-merger collusion, as punishments effected by price wars are weakened. We thus extend the result of Davidson and Deneckere [Davidson C, Deneckere R (1984) Horizontal mergers and collusive behavior. Internat. J. Indust. Organ. 2(2):117–132.], who analyzed the weakening of punishments post-merger, demonstrating that pre-merger collusion is weakened, in a fully stochastic model. Thus, although anticompetitive mergers harm competition ex post, the implication is that barriers and costs of merging due to regulation should be reduced to promote competition exante. This paper was accepted by Tomasz Piskorski, finance.