"Companies have faced issues about how to grow as the entertainment industry goes through major changes due to advanced computer technology and improved communications," the two companies said in a statement.

"This merger is Enix and Square's answer to that issue," they said. "We aim to become the world's top quality digital content maker."

Square, which specialises in developing software, is best known for its Final Fantasy game series, while Enix -- a software publisher -- produces Dragon Quest game titles.

Under the agreement, Enix will allocate 0.81 shares for every Square stock.

The new firm will be called Square Enix, the companies said.

Analysts welcomed the move and expected the pair to become more competitive.

"The combination of the software publisher and the software developer looks to be complementary," said Eiji Maeda, analyst at Daiwa Institute of Research.

"The merged firm will have a very strong marketing base in Japan, while it is also expected to be able to gain strength in independence and be able to obtain more favourable terms against console makers," he noted.

West LB Penmure analyst Zachary Liggett said by combining resources, business risks could be diluted amid stiffer competition in the industry.

"(The) only issue that needs to be addressed is how to fill the gap in the difference in their corporate culture," he said.

The merged firm may need to diversify their title line-up to ensure its survival in a tough global market, Maeda warned.

The merger throws the spotlight on a proposed three-way alliance between Square, Enix and commercial game equipment firm Namco Ltd, said Takashi Oka, chief analyst at UFJ-Tsubasa Research Institute.

Square and Enix, together with Namco announced a year ago a plan to form a three-way alliance, but the three have so far failed to come up with any strategic programme.

"How Namco will move is now the key," Oka said.

Shares in the two companies far outperformed the broader market.

Square jumped 6.4 percent or 121 yen to 2,005 and Enix soared 16 percent or 300 yen to 2,175. In contrast, Tokyo's Nikkei-225 index closed down 1.4 percent at 8,823.99 points.

SPACE.WIRE