Mergers between regulated firms with unknown efficiency gains

In an industry where regulated firms interact with unregulated competitors, we investigate the welfare effects of a merger between regulated firms when efficiency gains are uncertain before the merger and their realization becomes private information of the merged firm. The optimal merger policy trades off potential efficiency gains against regulatory distortions from informational problems. We show that, as a consequence of this trade-off, fiercer competition between unregulated firms induces a more lenient merger policy. However, if the regulated firms diversify into a competitive segment of the market, softer competition can relax the optimal merger policy.