Franco-German drugmaker Aventis has agreed to merge with Sanofi-Synthelabo after its smaller rival upped an earlier bid.
Government backing can prove a useful tool in takeovers
Aventis has fought the hostile takeover since rejecting it in February.
The French government, however, encouraged Sanofi to raise its offer after Switzerland's Novartis last week said it wanted to buy Aventis.
The move will create the world's third-largest medicine producer behind Pfizer and GlaxoSmithKline.
France's Prime Minister Jean-Pierre Raffarin said that: "The choice of a merger between Sanofi and Aventis will allow the preservation of decision centres and jobs in France and Europe, and is in line with a strategic interest".
Sanofi said Monday that it had raised its original offer of 47bn euros to just under 54bn euros.
The company is now offering investors five of its shares plus 120 euros in cash for every six Aventis shares.
Sanofi said that the deal had been approved by the Aventis board.
Novartis, meanwhile, said on Sunday that it had withdrawn from the race, "following Aventis' decision to engage in discussions with Sanofi, at the strong intervention of the French government".
"Ultimately, Norvartis wasn't going to provide much more money for Aventis, and therefore Aventis could do a better deal with Sanofi," Jo Walton of Lehman Brothers bank told the BBC's World Business Report.
Sanofi wants to buy Aventis partly to avoid becoming a target itself after a key shareholder pact between L'Oreal and Total expires in December. The cosmetics and oil companies together own 44% of Sanofi.
The synergies are persuasive; Aventis has a powerful presence in the huge US market, but a relatively weak inventory of new drugs -- called a drugs pipeline in the pharmaceutical industry -- while Sanofi is the opposite; a full pipeline, but a poor presence in the US.
However the aggressive French state intervention has upset the Germans -- shareholders in Aventis -- and the Swiss, who own Novartis.
And there is some anxiety among observers that Sanofi is involved in a drugs patent dispute that could yet cost it -- and its new shareholders. That danger could have been excluded if the rival Novartis had bid and won.
European Union approval should be straightforward after Sanofi agreed to sell some drug brands to overcome antitrust concerns.