A Theory of Strategic Mergers

Abstract. We examine firms strategic incentives to engage in horizontal mergers. In a real options framework, we show that strategic considerations may explain abnormally high takeover activity during periods of positive and negative demand shocks. Importantly, this pattern emerges solely as a result of firms strategic interaction in output markets. We show that the U-shaped relation be-tween the state of demand and the propensity of firms to merge, documented in past studies, is driven by horizontal mergers in industries that are: (1) relatively more concentrated, (2) characterized by relatively strong competitive interaction among firms, and (3) characterized by relatively low merger-related operating synergies and restructuring costs. The empirical evidence, based on para-metric and semi-parametric regression analyses, is consistent with these predictions. JEL Classification: G34 1