Innovation Spillover and Merger Decisions

Merger activities in innovative industries point to a relation between mergers and innovation. Firms' innovative ideas may spillover to other firms dis-incentivizing innovation activities, and merger may be a way to capture innovation spillover. The merger-innovation nexus has been well studied in the theoretical literature and recently in empirical papers, but empirical evidence on merger and innovation spillover is limited. In this paper, we investigate the impact of innovation spillovers on the likelihood of firms to merge, using a panel data set of mergers among publicly traded U.S. manufacturing firms from 1980 to 2003. In our empirical model, we also control for business cycles and proxies of neoclassical, behavioural and Q theories of mergers. Innovation is measured using R&D investments and citation-weighted patents, and innovation spillover is proxied using the technological proximity of firms. As a source of R\&D spillover (outward spillover), a firm can internalize its spillover effects by acquiring targets that benefit from the spillover. As a receiver of an R&D spillover (inward spillover), a firm may want to merge to control the negative impact of others' innovation on its competitive edge. We find that innovative firms are on average more likely to merge. These findings are robust to using a measure of patent ownership fragmentation as our instrumental variable. Our results also show that within-industry inward R&D spillovers increase mergers, but between-industry inward R&D spillovers do not influence merger decisions significantly. Our main results are robust to alternative measures of spillovers and different estimation methods.