Horizontal Mergers and Incremental Innovation

We study the impact of horizontal mergers on the incentives of merging firms to invest in incremental innovation. We provide a decomposition of this impact that clarifies the various forces at work and the differences between demand-enhancing and cost-reducing innovation. Moreover, we derive sufficient conditions for a merger to either reduce or raise the merging firms' incentives to innovate, and show that the comparison of the price diversion ratio and the innovation diversion ratio can help screen mergers. We also uncover a useful connection between the level of production synergies induced by a merger and its impact on innovation.