Horizontal Mergers and Divestment Dynamics in a Sunset Industry

In an oligopolistic market, socially excessive entry takes place because of business-stealing effect which is a gain to the entrant but not to the industry as a whole. Similarly, in a sunset industry with declining demand, now socially excessive capacity cannnot be dissolved because everyone intends to free ride on the reduction of industry supply expected from someone else’s divestment. As a result, no firm will divest, even though divestment contributes to the saving on fixed costs. This paper highlights the role of mergers as a device for internalizing the business-stealing effect and thereby promoting divestment, and examines if the merger-induced divestment could improve the total welfare using the case of cement mergers in Japan. A model of divestment based on the Markov perfect equilibrium framework of Ericson and Pakes (1995) is estimated by an asymptotic least squares. Then a counterfactual experiment is conducted to quantify the welfare impact of mergers, and to show that merged firms in fact divested their facilities more and contributed to the improvement of the total welfare despite the reduced consumers surplus.