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 knowledge spillovers, competition discourages investment in R&D due to free-riding, and by internalizing such externalities, a merger can improve the incentives for innovation. Horizontal mergers raise (reduce) innovation if the spillover effect is large (small), in contrast with the standard account of spillover effects on mergers