Multidivisional firms, internal competition, and the merger paradox

Traditional modelling of mergers has the merged firms (insiders) cooperate and maximize joint profits. This approach has several unappealing results in quantity-setting games, for example, mergers typically are not profitable for insiders, but are profitable for non-merging firms (outsiders). We take a different approach and allow for a parent company that can play each insider off one another. In quantity-setting games, with our approach mergers are profitable for insiders, unprofitable for outsiders, socially beneficial, and involve (in a non-monopolizing merger) a small number of firms. Finally, we find that the optimal strategy depends on whether firms compete in quantity or prices.