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When to Initiate an International Vertical Merger? The Impact of Negative Demand Shock


  • Jie Li would like to thank the support by the Project of Humanities and Social Sciences (2010), the Chinese Ministry of Education (10YJC790130) and the project of Zhejiang Provincial Natural Science Foundation of China (LY13G020002). Xianhai Huang (the corresponding author, e-mail: is grateful for the financial support of National Social Science Foundation of China (No. 11AZD009), Key Project of Chinese Ministry of Education (No. 2009JJD790044), and the project of Centre for research in regional economic opening and development of Zhejiang province (11JDQY01YB). The authors would also like to thank the editor, two anonymous referees and the participants of the Third IEFS China Conference 2011 for their valuable comments and suggestions and Hong Ma for her research assistance. All the remaining errors are, of course, ours.


This paper develops an extended Hotelling-type product and technology-differentiated model with two upstream and two downstream firms. The US upstream (respectively downstream) firm is technologically more advanced than the Chinese upstream (respectively downstream) firm. The locations of the upstream firms and the US downstream firm are fixed, and the Chinese downstream firm chooses its product location. The downstream firms compete with each other in US market. We aim to explore the conditions under which an international vertical merger between the Chinese downstream firm and the US upstream firm occurs and its welfare implications. We show that the incentive for the Chinese downstream firm to initiate a technology-acquiring international vertical merger crucially depends on the market conditions of the United States. As compared to exporting or domestic vertical merger, international vertical merger is by no means an optimal choice for the Chinese downstream firm when there is no negative demand shocks to US market. This result remains to hold when the US downstream firm also has the option of initiating a merger with the US upstream firm. Nevertheless, in the case of a negative demand shock, a profitable international vertical merger may occur. However, such mergers worsen the social welfare of the United States.