Regulators have long focused on preventing “killer acquisitions,” where large corporations absorb small startups to eliminate potential competition and consolidate market power. This approach aims to safeguard competition in the marketplace. However, critics argue that such regulations might inadvertently stifle innovation, as startups often innovate with the hope of being acquired by larger firms that can provide substantial rewards without requiring them to bring products to market independently.

Regina Seibel, an assistant professor at the University of Toronto’s Rotman School of Management, highlights that banning these acquisitions could deter startups from entering the market. She argues that startups may choose not to innovate if the potential for lucrative acquisitions is diminished. This perspective challenges the conventional wisdom that blocking acquisitions is always beneficial for fostering competition.

To explore the implications of these regulatory measures on innovation, Prof. Seibel and her colleagues employed mathematical models based on game theory. Their findings suggest that outright bans on acquisitions dampen innovation. This outcome arises because startups may pursue fewer innovative projects without the prospect of acquisition. Additionally, larger companies, unable to acquire innovations, might duplicate efforts rather than develop new ideas independently.

However, the impact on innovation varies across different scenarios. In cases where startups need more bargaining power or stand to gain little from being acquired, banning acquisitions might enhance competition with minimal effect on innovation. Conversely, if a startup possesses a groundbreaking invention, prohibiting its acquisition may have a negligible impact on innovation, as the startup can still profit significantly by commercialising its product independently.

While “killer acquisitions” receive significant attention, allowing what is termed “genuine” acquisitions to proceed unchecked poses its risks. Allowing large companies to expand freely through acquisitions can exacerbate market concentration, potentially stifling future startup competition. This dynamic underscores regulators’ complexity in balancing competition concerns with innovation incentives in the marketplace.

In practice, regulating acquisitions effectively is challenging. Prof. Seibel and her colleagues propose nuanced approaches beyond outright bans. One alternative is taxing acquisitions, which reduces the financial gains for both parties involved while avoiding the complete prohibition of acquisitions. This approach aims to moderate the impact on competition while allowing some acquisitions to proceed under more controlled conditions.

Another strategy involves subsidising startups that choose to go public instead of seeking acquisition. By enhancing the profitability of going public, these subsidies can incentivise startups to remain independent and continue innovating without relying on acquisition as their primary exit strategy. Prof. Seibel views this as a promising avenue for fostering innovation while curbing the frequency of acquisitions that might harm competition.

While the regulation of acquisitions is intended to promote competition and prevent monopolistic practices, its impact on innovation is a critical consideration. The debate surrounding “killer acquisitions” highlights the delicate balance regulators must strike between preserving market dynamics and encouraging entrepreneurial innovation. By exploring alternative regulatory tools such as taxation and subsidies, regulators can mitigate the negative consequences of acquisitions on competition while preserving incentives for startups to innovate and thrive in competitive markets.

More information: Igor Letina et al, Killer acquisitions and beyond: policy effects on innovation strategies, International Economic Review. DOI: 10.1111/iere.12689

Journal information: International Economic Review Provided by University of Toronto Rotman School of Management