Horizontal Mergers and Innovation with Knowledge Spillovers

We introduce knowledge spillovers in a model of innovation competition à la (Federico et al., 2017) and Denicolò and Polo (2018), which otherwise features horizontal mergers that harm innovation due to the business-stealing effect. With spillovers across firms, competition discourages investment in R&D due to free-riding, while there may also be direct benefits within firms. Both channels of knowledge spillovers are important. In particular, by internalizing the free-riding externalities, a merger can improve incentives for innovation. Horizontal mergers raise (reduce) innovation if the spillover effect is large (small).