A Cournot model of mergers with cost-reducing R&D and spillovers

The European Commission, and competition authorities elsewhere, have recently turned their attention to the effect of mergers on innovation incentives. This paper sheds light on the effect of mergers on innovation in a Cournot setting with marginal cost-reducing investments and spillovers. Spillovers endogenously affect the equilibrium outcome because a fraction of one firms' investment adds to the investment of the other firms. Interestingly, when spillovers among merging and non-merging firms are the same, it is possible for the quantity of the merging firms to increase. This contrasts the well known merger paradox. Moreover, it is possible for the profits and aggregate investment to increase. This happens for certain parameters. There are mergers that increase investment and lower the market price, however, these mergers are not incentive compatible. If the European commission has an interest in promoting innovation, they should approve the mergers that will increase investment even though prices will rise.
Furthermore, the European Commission could try to identify markets in which a merger leads to higher investment and a lower price, but where a merger is not incentive compatible. Here a merger would be welfare improving but does not occur. By offering firms in this type of market a subsidy if they merge, total welfare can increase.