Can Mergers Drive Drastic Innovations?

This paper examines how mergers affect firms’ incentives to invest in drastic versus nondrastic innovations when there are no efficiency gains. In competitive markets with few firms engaged in R&D, mergers between these firms encourage investment in drastic innovations. However, when many firms are R&D active, mergers shift investment toward nondrastic innovations, reducing the likelihood of drastic innovations. Using the consumer welfare standard, the analysis shows that mergers improve overall welfare when they lead to increased investment in drastic innovations. The robustness of this result is shown through various extensions.