Diversification: Mergers & Efficiency

Trey Hatcher

My paper examines the merger phenomenon over the past Century and the process of horizontal, vertical, and conglomerate mergers as a means of within-industry product diversification, industrial diversification, and geographic diversification.  The impacts of these three types of diversification on market power, efficiency, and productivity suggest a market power and efficiency tradeoff.

Below are some highlights from the results of mergers for the three types of diversification mentioned above:

Within-Industry Product Diversification:

Increased multi-market competition, and only successful in cases of tacit collusion and superior understanding of competitors’ cost structures.  However, this is not likely given competitors entrance into new, unfamiliar markets. Evidence also suggested that dominant firms do in fact wage price wars with fringe firms, harming firm performance.

Industrial (Multi-Industry) Diversification:

The DuPont method proves ineffective in practice; the allocation of capital is supposed to flow to more profitable divisions, but the least profitable divisions often receive heavy subsidies, destroying the premise behind multi-industry diversification. There were also very complex management structure concerns. Lichtenberg’s studies actually show that de-diversification increases firm productivity.

Geographic (International) Diversification:

This is a relatively recent phenomenon in the most recent merger wave in the 2000s. It is particularly interesting because internationally diversified firms are sold at a premium compared to their domestic counterparts. While geographic diversification has a less negative impact on firm efficiency and productivity then the other two, the complex management, excess capacity, and more complex cost structure concerns make it a net negative benefit.

Ultimately, empirical evidence suggests that mergers that seek to achieve within-industry product diversification, industrial diversification, and geographic diversification may see differing initial market power gains, but the long-term efficiency and productivity losses make their impact a net negative on firm performance. Particularly, evidence suggests that dominant firms often take place in price wars with fringe firms, even though they would be better off ignoring them.

It is clear from historical evidence that mergers have created “bubbles” that have ultimately ended in sharp recessions. More research, therefore, needs to be done to examine why mergers continue to take place, and if the incentive system in place for executives and the lack of regulation regarding mergers and antitrust is not only harming production efficiency, but also harming consumers.

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