CAPACITY CONSTRAINT, MERGER PARADOX AND WELFARE-IMPROVING PRO-MERGER POLICY (2016)
Author: Baomin Dong, Guixia Guo, Xiaolin Qian and Frank
Yong Wang
Abstract
In this paper, we show
that the "Merger Paradox" (Salant, Switzer and Reynolds, 1983) is mitigated
when capacity constraint is considered. This is because outside firms who do
not participate in a merger cannot expand their output beyond their existing
capacity, and therefore, Stigler type of free riding is alleviated. When
overcapacity is socially costly, it is also shown that a pro-merger fiscal
policy may discourage ex ante capacity investment and hence alleviate
overcapacity, if capacity building is not too costly. Furthermore, it can be
shown that the optimal pro-merger subsidy is always welfare improving when it
discourages capacity building.
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