Zhou, Wen, Associate Professor, University of Hong Kong

We study how an industry reorganizes through mergers and divestitures in the face of exogenous shocks. Firms are assumed to have increasing marginal costs, which enables the modelling of divestitures as reverse mergers. We show that any change to the industry's organization through mergers and divestitures can be attributed to a demand shock, either positive or negative. Although the two restructuring activities are driven by opposite forces, the interaction between them generally pushes the industry toward higher concentration. We demonstrate how, facing the threat of divestitures, firms may engage in a series of mergers even though none of them is profitable and every divestiture is profitable. This may account for the observation that mergers are very common in real life, while divestitures are rare.

Keywords: divestitures, mergers, endogenous mergers, demand shock