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CRIEFF Discussion Paper Number 1201

Horizontal Agreements and R&D Complementarities: Merger versus RJV

Ben Ferrett (School of Business and Economics, Loughborough University; GEP, University of Nottingham) and Joanna Poyago-Theotoky (Research Affiliate CRIEFF, University of St. Andrews; School of Economics, La Trobe University; Rimini Centre for Economic Analysis (RCEA); SIERC, Massey University)

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Abstract

We study the decision of two firms within an oligopoly concerning whether to enter into a horizontal agreement to exploit complementarities between their R&D activities and, if so, whether to merge or form a research joint venture (RJV). In contrast to horizontal merger, there is a probability that an RJV contract will fail to enforce R&D sharing. We find that a horizontal agreement always arises. The insiders’ merger/RJV choice involves a trade-off: While merger offers certainty that R&D complementarities will be exploited, it leads to a profit-reducing reaction by outsiders on the product market, where competition is Cournot. Greater brand similarity and contract enforceability (“quality”) both favour RJV, while greater R&D complementarity favours merger. Interestingly, the insiders may choose to merge even when RJV contracts are always enforceable, and they may opt to form an RJV even when the likelihood of enforceability is negligible.

JEL codes: O30, L13, D43
Keywords: horizontal merger, research joint venture (RJV), contract enforceability,
process R&D, R&D complementarity.

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