05.07.2024Regulating Start-up Acquisitions: Innovation vs. Competition?

A recent study by Armin Schmutzler, Professor of Economics at the Department of Economics, Igor Letina from the University of Berne, and Regina Seibel from the Unviersity of Toronto, asks how competition policy should handle start-up acquisitions. The authors use game-theoretical models to analyze how innovation is affected under a host of scenarios. It turns out that innovation may be depressed when acquisitions are banned because there is a lower variety of projects. Besides discouraging startups who want to be bought, larger companies are motivated to duplicate the start-ups innovation, since they can’t just buy it, instead of exclusively pursuing their own ideas.

Banning start-up acquisitions might be too extreme

That said, such effects may well be negligible: If the startup doesn’t have much bargaining power and will not significantly profit from a buyout, a ban can boost competition with a small impact on innovation. Similarly, the adverse effect of prohibiting acquisitions on innovations is likely to be negligible in industries where the incumbent firm is protected by size advantages, for instance, due to network effects.

However, regulators may lack the precise understanding of the market that would be necessary to fine-tune the treatment of acquisitions to circumstances. But this does not mean that outright prohibitions of start-up acquisitions are the only alternative to the current lenient approach. Instead, the authors advocate less extreme approaches such as taxing acquisitions, which reduces the profits that can be made by both sides and thus reduces the number of acquisitions that will be carried out. Similar effects can be achieved by making it more attractive for start-ups to launch on the stock market with preferential tax treatment or subsidies.

Interview with Regina Seibel from the University of Toronto