This paper investigates the motive of pre-empting technology competition through mergers and acquisitions (M&A). Exploiting the patent application procedure at the European Patent Office we introduce a new measure for the possibility to create entry barriers in technology markets. Our results show significant evidence that firms engage in horizontal M&A to pre-empt competition in technology markets. --pre-empting technology competition,mergers and acquisitions

Grimpe, Christoph

Hussinger, Katrin

English

Research Papers in Economics

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Grimpe, Christoph; Hussinger, Katrin
Working Paper
Pre-empting Technology Competition
Through Firm Acquisitions
ZEW Discussion Papers, No. 07-027
Provided in cooperation with:
Zentrum für Europäische Wirtschaftsforschung (ZEW)
Suggested citation: Grimpe, Christoph; Hussinger, Katrin (2007) : Pre-empting Technology
Competition Through Firm Acquisitions, ZEW Discussion Papers, No. 07-027, http://
hdl.handle.net/10419/24587Dis  cus  si  on  Paper  No.  07-027
Pre-empting Technology Competition
Through Firm Acquisitions
Christoph Grimpe and Katrin HussingerDis  cus  si  on  Paper  No.  07-027
Pre-empting Technology Competition
Through Firm Acquisitions
Christoph Grimpe and Katrin Hussinger
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ftp://ftp.zew.de/pub/zew-docs/dp/dp07027.pdfNon-Technical Summary 
Mergers and acquisitions (M&A) can increase the merged entity’s market power in 
both product and technology markets. Whereas a potentially harmful effect of mergers 
in output markets can be predicted based on expected price changes after the 
acquisition, there is no standardized way how to detect a market power effect in 
technology markets. This has recently received scrutiny from antitrust authorities in 
order to ensure an appropriate level of competition. The statement that M&A can 
affect competition in technology markets is almost a triviality. However, whether the 
merged entity is able to enhance technological market power depends on whether the 
M&A creates barriers to entry in technology markets or whether the threat of future 
entry remains. 
This paper provides empirical evidence for the objective of pre-empting technology 
competition through M&A. We make use of the patent application procedure at the 
European Patent Office to introduce a new measure for the motive of creating entry 
barriers in technology markets. Based on a sample of horizontal acquisitions in 
Europe we show that acquiring firms pay more for targets with large patent stocks, for 
those with highly valuable patents as measured by patent forward citations and such 
with technologically related patent portfolios. On top of that we find that targets with 
a patent portfolio that has the potential to block other patents are of high value to the 
acquiring firm. We interpret this finding as evidence for a pre-emption motive of 
M&A. 
The paper concludes with a suggestion on how to access the potential to create entry 
barriers into technology markets. This could be of interest for competition authorities 
to sharpen their estimation of the impact of M&A on competition in technology 
markets. 
 Pre-empting Technology Competition  
Through Firm Acquisitions 
 
Christoph Grimpe
a and Katrin Hussinger
b,a,* 
 
aCentre for European Economic Research (ZEW), Mannheim (Germany) 
bK. U. Leuven (Belgium) 
 
 
May 2007 
 
 
Abstract 
This paper investigates the motive of pre-empting technology competition 
through mergers and acquisitions (M&A). Exploiting the patent application 
procedure at the European Patent Office we introduce a new measure for 
the possibility to create entry barriers in technology markets. Our results 
show significant evidence that firms engage in horizontal M&A to pre-empt 
competition in technology markets. 
 
Keywords: pre-empting technology competition, mergers and acquisitions 
 
JEL: G34, L20, O34 
* Corresponding author, Katholieke Universiteit Leuven (KUL), Department of Economics & Applied Economics, 
Naamsestraat 69, 3000 Leuven, Belgium, Tel.: +32(0)16/326899, E-mail: katrin.hussinger@econ.kuleuven.be 
We thank Patrick Beschorner, Dirk Czarnitzki, Bronwyn Hall and Christian Rammer for helpful comments and 
discussions. Katrin Hussinger gratefully acknowledges financial support under the grant KUL – OT/04/07A.   2
1  Introduction 
Mergers and acquisitions (M&A) can increase the merged entity’s market power in 
both product and technology markets. The latter has recently received scrutiny from 
antitrust authorities (e.g. European Commission, 2005). The statement that M&A can 
affect competition in technology markets is almost a triviality. However, the ability of 
the merged entity to enhance technological market dominance depends on whether the 
M&A creates barriers to entry in technology markets or whether the threat of future 
entry remains. 
This paper provides empirical evidence for the objective of pre-empting technology 
competition through M&A. We make use of the patent application procedure at the 
European Patent Office to introduce a new measure for the motive of creating entry 
barriers in technology markets and find significant evidence for a pre-emption motive 
of M&A. 
2  Theory 
Since the seminal work by Joseph Schumpeter and Kenneth Arrow the theoretical 
literature on innovation incentives under the pressure of competition is well 
developed (see Reinganum, 1989, for a survey). These models can explain pre-
emptive behaviour in technology markets. Recent developments are mainly based on 
two models, the auction model by Gilbert and Newbery (1982) and the stochastic 
racing model by Reinganum (1983).
1 
Gilbert and Newbery (1982) consider an incumbent firm that faces competition by 
one or more potential entrants. The firms compete for a process innovation of a third 
party. The firm with the highest bid, which is determined by its maximum expenditure 
for R&D, wins the auction. If the challenger wins the auction market entry takes 
place. The model predicts that incumbent firms have greater incentives to bid more 
than potential entrants because of pre-emption motives, i.e. to preclude entry.  
While the model by Gilbert and Newbery is static, Reinganum (1983) proposes a 
stochastic racing model. In her model, an innovation occurs after an unknown time 
                                                 
1 For an empirical test of the oppositional predictions of both models see Czarnitzki and Kraft (2004).   3
period. The length of that period depends on the amount of the firm’s R&D 
expenditure in the market. The incumbents have less incentives to innovate than 
potential entrants as the innovation would cannibalize their existing profits, i.e. the 
replacement effect (Arrow, 1962). 
Gans and Stern (2000) build on Reinganum (1983) and propose a model in which 
technologically successful entrants can cooperate in the post-innovation market with 
the incumbent through licensing or firm acquisitions. In their model, incumbents have 
strategic incentives to invest in R&D because innovation increases their bargaining 
power in licensing and M&A negotiations. As in Reinganum’s model, incumbents are 
likely to invest less than potential entrants, who make their profits in the market for 
ideas rather than in the post-innovation market. 
In line with the predictions of the theoretical literature, empirical studies show that 
technological assets increase the likelihood of being acquired (see Veugelers, 2006, 
for a survey), especially if the target’s technologies are highly valuable and related to 
the acquiring firm’s technology portfolio. The particular question whether firm 
acquisitions aim at creating barriers to entry into technology markets has, however, 
not yet been tackled. 
3  Data and Variable Definition 
Our sample of 657 target firms with known deal values is taken from the ZEPHYR 
database of Bureau van Dijk Electronic Publishing (BvDEP). We identified 
manufacturing firms located in Europe that were subject to a horizontal acquisition in 
the period 1997-2003.
2 Financial information is added from BvDEP’s Amadeus 
database.
3 In order to get information on target firms’ innovation activities the patent 
history of the firms is taken from the database of the European Patent Office (EPO). 
The data were linked using a computer supported text search algorithm on firm names 
and addresses. Each match proposed by the search engine was checked manually. 
We use four measures to describe the attractiveness of each target i’s technological 
assets. As a measure for quantity of innovations we use the patent stock: 
                                                 
2 Horizontal acquisitions are characterized as a transaction with the acquirer and target company being from the 
same industry as defined in terms of the NACE (2-digit) classification. 
3 Additional statistics on the sample, e.g. country and industry distribution, are available upon request.    4
it t i it ns applicatio patent PS PS _ ) 1 ( 1 , + − = − δ  
δ represents a constant knowledge depreciation rate, which is set to 15 percent in line 
with previous studies (e.g. Hall, 1990).  
Patent quality is measured by the target’s citation rate, i.e. the number of forward 
citations the target’s patents receive in a five year window over the total number of 
patents.  
To control for technological proximity of the patent portfolios of acquiring and target 
firm we use the proximity measure introduced by Jaffe (1986). In order to calculate 
this measure we determined for each firm patent stocks for each 2-digit technology 
class according to the International Patent Classification (IPC). This yields a 
technology vector F for each target i and acquirer j, which can be interpreted as their 
technology portfolio. Using these vectors (as a percentage of the total patent stock) 
technological proximity T is now calculated as: 
1 0 ;
) ' )( ' (
≤ ≤ = ij
j j i i
j i
ij T
F F F F
F F
T  
Finally, building on Harhoff et al. (2005) we introduce a new measure to map pre-
emptive behavior in technology markets, which is done by making use of the patent 
application procedure at the EPO (see Harhoff and Reitzig, 2004, for a detailed 
description). The EPO patent examiner prepares a search report for each patent 
application in order to evaluate whether the invention fulfils the novelty requirement 
for protection by a patent. In particular, the search report lists all relevant prior art, 
patents and other documents, and classifies them with respect to their relevance for 
the invention in question. Prior art is classified with an X if - even when taken alone - 
a claimed invention could possibly not be considered novel. Referenced documents 
are categorized with a Y if the document threatens novelty only if combined with 
other documents. Hence, the more X and Y references a patent application receives 
the less likely it will be granted. For our analysis we use the X and Y forward 
citations within a five year window which indicate to what extent a particular patent 
threatens other patents’ chance for being granted. The more X and Y forward citations 
a patent receives, the higher its strategic value for pre-empting competition in 
technology markets.    5
Table 1 shows the descriptive statistics for non-patenting and patenting acquisition 
targets. 16 percent of the acquisition targets have a positive patent stock, i.e. they have 
applied for a patent at the EPO at least once since firm foundation. On average, 
patenting firms are associated with a higher deal value and a higher deal value per 
total assets than the average non-patenting target. They are, however, less profitable 
than the average target without patents as indicated by their return on assets, defined 
as the sum of profits and capital gains of assets over total assets in the year prior to the 
acquisition. The average patenting firms is not different with respect to its leverage 
defined as liabilities over total assets. All variables refer to the year prior to 
acquisition. 
Table 1: Descriptive statistics 
  European Acquisition Targets 
Number of observations = 657 
 Mean  St.dev. 
Firms without EPO patents:  Number of observations = 553 
Deal value (M Euro)  68.852  224.461 
Total assets (M Euro)  174.418  479.002 
Return on assets (%)  3.194  16.542 
Leverage 0.583  0.231 
Age (years)  21.342  23.630 
    
Firms with EPO patents:  Number of observations = 104 
Deal value (M Euro)  285.039  577.397 
Total assets (M Euro)  316.506  597.993 
Return on assets (%)  -3.235  23.685 
Leverage   0.530  0.238 
Age (years)  22.055  25.122 
Patent stock  37.922  107.341 
Techn. proximity   0.019  0.066 
# Citations/# patents   0.956  0.796 
# XY citations/# citations   0.262  0.261 
 
4  Empirical Results 
In order to investigate whether pre-empting competition in technology markets is an 
objective of M&A we define the acquired company in a hedonic way as a bundle of 
its characteristics and assets and conduct a multivariate regression for the deal value. 
The specification follows the market value literature (see Czarnitzki et al., 2006, for a 
survey).    6
Table 2 shows the estimation results. It turns out that technological assets are of high 
value to the acquiring firm as they raise the deal value significantly. Besides the 
quantity of patents (patent stock/assets), their value (#citation/#patents) and their 
relatedness to the patent portfolio of the acquiring firm (techn. prox.) the results show 
that firms have a clear preference for acquisition targets with potentially blocking 
patents (#XYcitations/#citations). The deal value of a target increases by 13% if there 
is a 0.01 increase in the blocking potential of the target firm’s patent portfolio. This 
corresponds to an increase of the deal value by approximately 37M Euro for the 
average patenting firm. 
Table 2: OLS regression for the log(deal value) 
 (1)  (2)  (3)  (4) 
 
Coefficient 
(St.err.) 
Coefficient 
(St.err.) 
Coefficient 
(St.err.) 
Coefficient 
(St.err.) 
Log(total  assets)  0.40 ***  0.40 ***  0.39 ***  0.38 *** 
  (0.03)   (0.03)   (0.03)   (0.03)   
Return  on  assets  0.01 ***  0.01 ***  0.01 ***  0.01 *** 
  (0.00)   (0.00)   (0.00)   (0.00)  
Leverage  -0.40   -0.39   -0.39   -0.39  
  (0.25)   (0.26)   (0.25)   (0.26)  
Age  0.01 ***  0.01 ***  0.01 ***  0.01 *** 
  (0.00)   (0.00)   (0.00)   (0.00)  
Patent  stock/assets  0.18 ***  0.18 ***  0.17 ***  0.14 *** 
  (0.05)   (0.05)   (0.05)   (0.04)  
Techn.  prox.      7.82 **  6.91 **  5.85 * 
      (3.20)   (3.20)   (3.08)  
(Techn. prox.)
 2      -14.99 **  -14.22 **  -11.87 * 
      (6.51)   (6.52)   (6.24)  
#Citations/#patents       0.14  ***  0.10  *** 
       (0.04)   (0.04)   
#XYcitations/#citations          1.13  *** 
         ( 0 . 4 1 )    
Constant  5.01 ***  5.04 ***  4.98 ***  5.12 *** 
  (0.46)   (0.46)   (0.46)   (0.46)   
Industry dummies  Yes  Yes  Yes  Yes 
Time dummies  Yes  Yes  Yes  Yes 
F-stat 12.09  11.74  11.94  12.64 
R
2  0.27 0.27  0.28  0.29 
***, **, * indicate statistical significance at the 1%, 5%, 10% level. 
Standard errors in parentheses are robust using the Huber/White correction. 
 
5  Conclusion 
This paper provides empirical evidence for the objective of creating barriers to entry 
into technology markets through firm acquisitions. In line with the predictions of   7
economic theory the estimation results show that firms with technologies that have the 
potential to deter entry are of high value to the acquiring firms. Our paper provides a 
suggestion for competition authorities to sharpen their estimation of the impact of 
M&A on competition in technology markets. 
 
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Pre-empting Technology Competition Through Firm Acquisitions

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Pre-empting Technology Competition Through Firm Acquisitions

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