Merger policy, entry, and entrepreneurship

We assess the impact of merger policy on entry and entrepreneurship. Facing uncer-tainty about its prospects and foreseeing that it may wish to quit should profitability prove poor, a rational entrant considers possible exit routes. Horizontal merger reduces competition subsequently, lowering welfare in the short run, but also provides a valuable exit route. By facilitating exit and thus raising the value of entry, more lenient merger policy may stimulate entry sufficiently that welfare is increased overall. We calculate the optimal merger policy in the form of a low, but positive, profitability threshold be-low which a merger is permitted despite its adverse impact on post-merger competition. This may be viewed as an extension of the “failing firm defense ” to include ailing, low profitability firms as well as imminently failing ones. The implications of strategic firm behavior for the optimal policy are examined, and merger policy is compared with an entry subsidy