Merger Activity In Industry Equilibrium

We study the effects of mergers and acquisitions on industry dynamics. We develop an infinite horizon model of a competitive industry, which features mergers, entry, exit, and investment by heterogeneous firms. Merger synergies arise from improvements in productivity and cost efficiencies. We characterize the time-series and cross-sectional evolution of firm productivities and merger opportunities in a rational expectations equilibrium. Consistent with the empirical evidence, our model generates procyclical entry and merger activity, as well as counter-cyclical exit. The presence of a merger market induces higher entry rates and lower exit rates, reduces the counter-cyclicality of exit, and increases the mean and variance of the cross-sectional distribution of firm-level productivities. While entry and exit induce the mean productivity to be counter-cyclical, this pattern is reversed when the possibility of mergers is taken into account.