Partial Equity Ownership and Knowledge Transfer

When firms form an alliance, it often involves one firm acquiring an equity stake in its alliance partner. Such an alliance lessens the competition, but induces knowledge transfer within the alliance. This paper explores oligopoly models that capture this important link between partial equity ownership (PEO) and knowledge transfer. We consider an industry consisting of three firms, where firm 1 has superior knowledge that other firms in the industry do not have. Firms 1 and 2 have an option of forming an equity strategic alliance in which firm 1 owns a fraction of firm 2’s share. The equilibrium level of PEO is endogenously determined in our model. Previous theoretical models of PEO, in which the levels of PEO are exogenously given, have shown that PEO arrangements would decrease welfare by reducing the degree of competition in the industry. We demonstrate that endogenously determined levels of PEO can increase welfare under a range of parameterizations. Our analysis indicates that there are three relevant policy interventions (prohibit PEO, partially permit PEO, or permit PEO) for antitrust authorities to maximize welfare, and shows that any one of the three can be optimal depending on parameterizations. JEL classification numbers: L10, L40, L50