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On synergies and vertical integration

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  • Schmitz, Patrick W.
  • Sliwka, Dirk

Abstract

We analyze in an incomplete contracts model whether a supplier should be integrated if in addition to his investment level he chooses the intensity of specialization towards the buyer's needs. A basic trade-off arises: While non-integration leads to higher investment incentives, potential synergies are foregone. Hence, integration can be optimal even though only the supplier makes an investment decision. This may also yield some insights for the discussion on which activities belong to a firm's core competencies. Furthermore, we show that if specialization is contractible, underspecialization will deliberately be chosen since investment incentives are thereby improved.

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Bibliographic Info

Article provided by Elsevier in its journal International Journal of Industrial Organization.

Volume (Year): 19 (2001)
Issue (Month): 8 (September)
Pages: 1281-1295

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Handle: RePEc:eee:indorg:v:19:y:2001:i:8:p:1281-1295

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Web page: http://www.elsevier.com/locate/inca/505551

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References

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  1. Grossman, Sanford J & Hart, Oliver, 1985. "The Cost and Benefits of Ownership: A Theory of Vertical and Lateral Integration," CEPR Discussion Papers 70, C.E.P.R. Discussion Papers.
  2. Maskin, Eric & Tirole, Jean, 1999. "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 66(1), pages 83-114, January.
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  5. Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law and Economics, University of Chicago Press, vol. 21(2), pages 297-326, October.
  6. Hart, Oliver D. & Moore, John, 1990. "Property Rights and the Nature of the Firm," Scholarly Articles 3448675, Harvard University Department of Economics.
  7. Oliver Hart & John Moore, 1998. "Foundations of Incomplete Contracts," Harvard Institute of Economic Research Working Papers 1846, Harvard - Institute of Economic Research.
  8. Raghuram G. Rajan & Luigi Zingales, 1997. "Power in a Theory of the Firm," NBER Working Papers 6274, National Bureau of Economic Research, Inc.
  9. Rosenkranz, Stephanie & Schmitz, Patrick W., 1999. "Know-how disclosure and incomplete contracts," MPRA Paper 12533, University Library of Munich, Germany.
  10. Kirk Monteverde & David J. Teece, 1982. "Supplier Switching Costs and Vertical Integration in the Automobile Industry," Bell Journal of Economics, The RAND Corporation, vol. 13(1), pages 206-213, Spring.
  11. Chiu, Y Stephen, 1998. "Noncooperative Bargaining, Hostages, and Optimal Asset Ownership," American Economic Review, American Economic Association, vol. 88(4), pages 882-901, September.
  12. Williams, I., 1996. "Integration and investment specificity," Discussion Paper Series In Economics And Econometrics 9614, Economics Division, School of Social Sciences, University of Southampton.
  13. Maskin, Eric & Tirole, Jean, 1999. "Two Remarks on the Property-Rights Literature," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 66(1), pages 139-49, January.
  14. Moore, John, 1992. "The firm as a collection of assets," European Economic Review, Elsevier, vol. 36(2-3), pages 493-507, April.
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  17. Rotemberg, Julio J & Saloner, Garth, 1994. "Benefits of Narrow Business Strategies," American Economic Review, American Economic Association, vol. 84(5), pages 1330-49, December.
  18. Jean Tirole, 1999. "Incomplete Contracts: Where Do We Stand?," Econometrica, Econometric Society, Econometric Society, vol. 67(4), pages 741-782, July.
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Citations

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Cited by:
  1. Sliwka, Dirk, 2003. "Management Incentives, Signaling Effects and the Costs of Vertical Integration," IZA Discussion Papers 856, Institute for the Study of Labor (IZA).
  2. Patrick W. Schmitz, 2000. "Partial Privatization and Incomplete Contracts: The Proper Scope of Government Reconsidered," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, Mohr Siebeck, Tübingen, vol. 57(4), pages 394-411, August.
  3. Richter, Alexander, 2010. "Industrielle Produkt-Service-Systeme: Eine vertragstheoretische Analyse," Arbeitsberichte des Lehrstuhls für Produktionswirtschaft 9, Ruhr-Universität Bochum (RUB), Lehrstuhl für Produktionswirtschaft.
  4. Schmitz, Patrick W., 2001. "The Hold-Up Problem and Incomplete Contracts: A Survey of Recent Topics in Contract Theory," MPRA Paper 12562, University Library of Munich, Germany.
  5. Herbst, Patrick & Walz, Uwe, 2009. "The design of vertical R&D collaborations," CFS Working Paper Series 2009/06, Center for Financial Studies (CFS).
  6. Schmitz, Patrick W., 2005. "Information Gathering, Transaction Costs and the Property Rights Approach," CEPR Discussion Papers 5417, C.E.P.R. Discussion Papers.
  7. Oberg, Christina & Holtstrom, Johan, 2006. "Are mergers and acquisitions contagious?," Journal of Business Research, Elsevier, vol. 59(12), pages 1267-1275, November.
  8. Alma M. dela Cruz, 2007. "Contractual Arrangements in Agriculture (Northern and Central Luzon Component)," Development Economics Working Papers 22626, East Asian Bureau of Economic Research.
  9. Andrew F. Newman & Patrick Legros, 2011. "Incomplete Contracts and Industrial Organization: A Survey," Boston University - Department of Economics - Working Papers Series WP2011-036, Boston University - Department of Economics.
  10. Mathias Erlei & Wiebke Roß, 2013. "Bounded Rationality as an Essential Ingredient of the Holdup Problem," TUC Working Papers in Economics 0009, Abteilung für Volkswirtschaftslehre, Technische Universität Clausthal (Department of Economics, Technical University Clausthal).

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