Mergers in the Presence of Adverse Selection

ABSTRACT

In the presence of adverse selection, mergers can increase welfare through a reduction in inefficient sorting. I characterize the sorting externality internalized between merging firms in a tractable discrete choice model. Mergers benefit consumers when the firms are small, willingness to pay is moderately increasing in cost, and consumer costs are skewed. Applying the model to the non‐group health insurance market, 13% of potential mergers would improve consumer surplus. In markets where the sorting distortion exceeds $5 per person, nearly one‐third of mergers improve consumer surplus, highlighting the importance of considering adverse selection in merger evaluation.