When Efficient Firms Flock Together: Merger Incentives Under Yardstick Competition

Local monopolists that are regulated by yardstick competition frequently merge with their peers. However, economic theory provides little guidance for merger analysis. In contrast, the theoretical model in this article shows that there can be room for strategic firm behaviour even in a setting where firms are many and collusion is not sustainable. Specifically, the article derives conditions under which firms propose welfare-decreasing mergers to avoid competition with efficient peers and establishes when peer effects discourage firms from implementing socially desirable mergers. Efficient peers flock together whereas inefficient firms remain independent, unless peer effects are counteracted by efficiency effects.