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The rest of our paper is organized as follows. In the next section, we place our work in the context of the relevant literature. Section 3 provides testable hypotheses. Section 4 describes the data and methodology. In Section 5, logistic regressions are used to assess the empirical link between the probability of cross-border M&A and market concentration. Section 6 offers a summary of our findings and conclusions.
2. Literature review: Cross-Border Mergers and Market Concentration
The literature on cross-border mergers, by any standard, is still at its infancy. Notwithstanding the fact that a third of worldwide mergers involve firms from different countries, the vast majority of the academic literature on mergers has been primarily limited to intra-national mergers.Among notable theoretical contributions are the works of Long and Vousden (1995), Head and Ries (1997), Falvey (1998), Reuer et al. (2004), Nocke and Yeaple (2007), Neary (2007), and Beladi et al. (2013). Long and Vousden (1995) analyzed the effects of tariff reductions on horizontal mergers in a Cournot oligopoly. They showed that unilateral tariff reductions encourage cross-border mergers which concentrate market power at the expense of mergers which reduce cost, while bilateral tariff reductions have the opposite effect, encouraging mergers which significantly reduce cost.
Head and Ries (1997) investigated the welfare consequences of horizontal mergers between firms based in different nations. They demonstrated that when mergers do not generate costs saving, it will be in the national interest for existing competition agencies to block most world welfare-reducing combinations. When mergers generate cost savings, national welfare-maximizing regulators cannot be relied upon to prevent mergers that lower world welfare. Falvey (1998) showed how the rules for approving an international merger should be adapted to account for the fact that the regulator is only concerned with domestic welfare i.e. ignores the effect of the merger on foreign firms and consumers. Reuer et al. (2004) have analyzed the role of sector-specific contractual heterogeneity of cross-border mergers in mitigating the problem of adverse selection. They pointed out that, in the case of international mergers, a key contractual variable is whether the parties agree to a performance-contingent payout structure which can mitigate the risk of adverse selection. Bertrand and Zitouna (2006) examined policy designs for international mergers. They showed that the effect of trade liberalization on merger incentives depends on the technological gap: for low and high (medium) gap, there is an inverted U- (W-) shaped relation between trade costs and incentives to merge. Nocke and Yeaple (2007) modeled cross-border mergers as international purchases and sales of country-specific firm capabilities. They demonstrated that the degree to which firms differ in their mobile and non-mobile capabilities plays a crucial role for the international organization of production: depending on whether firms differ in their mobile or immobile capabilities, cross-border mergers may involve
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the most or the least efficient active firms. Neary (2007) constructed the first analytically tractable general equilibrium model of cross-border mergers where he showed how trade liberalization can trigger international merger waves through bilateral mergers in which it is profitable for low-cost firms to buy out higher-cost foreign rivals. Beladi et al. (2013) argue that the vertical structure introduces a distinction between the foreign and domestic firm even in the absence of transport costs since mergers can affect competition in input markets creating, in addition to the usual market power motive, an input-market concentration effect.
While each of these studies has pushed the boundaries of our understanding of mergers across borders, all of them have focused on the horizontal aspects of such mergers. Our work complements this literature in recognizing the importance of the role played by the vertical structure of these industries in which cross-border mergers have been initiated. In particular, the significance of the vertical dimension of horizontally merging firms is evident from the initiatives taken by suppliers (of large retail chains) seeking to control the costs of purchasing and carrying inventories by cutting down on the number of vendors. A cross-border horizontal merger involves firms producing substitutes in two distinct countries with the consequence that such a merger will remove direct competitive pressures absent other constraining factors or offsetting efficiencies. When cross-border horizontal mergers take place in industries that are vertically related, they present a greater challenge for competition authorities since the vertical structure itself affects the intensity of competition. We analyze cross-border horizontal mergers in a vertically related oligopolistic industry capturing the incentives for and implications of cross-border mergers apparent in international data.
From an analytical perspective, the vertical structure injects a distinction between the foreign and domestic firm even in the absence of transport costs since mergers can affect competition in input markets creating, in addition to the usual market power motive, an input-market concentration effect. We argue that vertical integration can act as a foreclosing device reducing upstream competition and hence raising the input price for the disintegrated downstream rivals. In particular, we try to capture the possibility of augmenting the gains from cross-border horizontal mergers when a vertically integrated production structure exists. We are also able to highlight the importance of the interaction between efficiency and concentration since a merger between a high-cost and a low-cost firm increases efficiency by eliminating the high-cost firm and raises price by increasing concentration.
The existing empirical literature documents many potential factors that are associated with cross-border M&A. Rose (2000) argue that physical distance can increase the cost of cross border M&A and the level of market development and corporate governance are also likely to affect cross border M&A. Using a large panel data set of cross-border M&A deals for the period 1990–1999, Giovanni (2005) show that the size of financial markets has a strong positive association with domestic firms investing abroad. Jovanovic
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and Rousseau (2008) find that mergers play an important role in reallocating assets toward an economy’s more efficient firms. Chari, Ouimet and Tesar (2009) show that acquirer from developed markets benefit more from weaker governance environments in emerging markets. Alfaro and Charlton (2009) assess the importance of comparative advantage considerations in the determination of FDI. They show that trade costs and an increase in the subsidiary country skill level have negative and significant effects on the level of multinational activity. The interaction term of country skill abundance and industry skill intensity is positively related to FDI. They also show that intra-firm FDI between rich countries in high skill sectors is consistent with the notion that firms in high institution countries with sophisticated inputs engaging more in FDI.
Erel, Liao and Weisbach (2012) analyze cross-border mergers in 48 countries between 1990 and 2007. They find that geography, the quality of accounting disclosure and bilateral trade increase the likelihood of mergers between two countries. Ahern, Daminelli and Fracassi (2013) find that the volume of cross-border M&A is affected by national culture characteristics such as trust, hierarchy and individualism. Weinberg and Hosken (2013) use a static Bertrand model to directly estimate the price effects of two mergers.
Bernile, Lyandres and Zhdanov (2012) show that the U-shaped relation between the state of demand and the propensity of firms to merge is driven by horizontal mergers in industries that are more concentrated and characterized by relatively strong competitive interaction among firms. We draw on this body of work when testing the predictions of our theoretical construct.
3. Hypotheses development: Determinants of cross-border M&As
Our hypotheses are derived from the theoretical results which shown that competitive advantage interacts with comparative advantage to determine cross-border M&A (Neary, 2007 and Beladi et al., 2013). Beladi et al., (2013) show that vertical integration at home increases the gains from cross-border mergers. We argue that when an upstream firm is integrated with a downstream firm at home, a relatively efficient foreign firm will have an incentive to acquire a disintegrated home firm. In other words, the incentives for cross-border mergers rise with vertical integration when the pre-merger market competition at home is sufficiently low relative to the competition in the foreign country. Intuitively, this follows from an interaction between efficiency and concentration as a merger between a high-cost and a low-cost firm increases efficiency by eliminating the high-cost firm. The larger the cost differential, the greater is the gain from a low cost firm taking over a high cost firm. Vertical integration affects relative costs through its effects on competition in the input market. The profits of the downstream unit of the integrated firm increase with a rise in its rivals’ costs and the integrated firm is better off withdrawing from the input market. The
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withdrawal of a vertically integrated firm from the input market weakens upstream competition. This raises the input price which, in turn, leads to a higher cost for the non-integrated downstream firms.
The profits of a low-cost foreign firm must increase significantly to justify its taking over a high-cost home firm. When this cost differential is sufficiently large, the foreign firm has a greater incentive to merge with the integrated home firm than to merge with a disintegrated home firm. Vertical integration at home makes foreign downstream firms more competitive and the disintegrated domestic downstream firms less competitive. As such, a vertical integration at home changes the strategic advantages for foreign firms.
With the vertically integrated home-firm operating at a lower cost relative to the disintegrated home firms, the increase in the profits of a foreign firm from a merger with an integrated home firm exceeds the increase in its profits from a merger with a disintegrated home firm when there are fewer disintegrated firms at home in the pre-merger equilibrium. In other words, the incentives for a merger between a foreign firm and a vertically integrated home firm will be higher (lower) than that for a merger between a foreign firm and a disintegrated home firm, when the pre-merger competition at home is high (low) relative to the pre-merger competition in the foreign country.