Does the Potential for Mergers Reduce Competition?∗

We study the effect of horizontal mergers in a dynamic model with noisy collusion. At each instant firms either privately choose output levels or merge to create a monopoly. In equilibrium, merging trades off the benefits of avoiding price wars against costs of merging, net of higher profits due to lower competition. There are three results. First, mergers are optimal when collusion fails (i.e., firms sufficiently deviate from a collusive regime). Second, long periods of collusion are likely, because colluding is dynamically stable. Therefore, mergers are rare. Third, mergers (and, in particular, lower merger costs) decrease pre-merger collusion, as punishments by price wars are weakened. Thus, although anti-competitive mergers harm competition ex-post, barriers and costs of merging due to regulation should be reduced to promote competition ex-ante. JEL Classification Numbers: D43, L12, L13, G34.