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A Price Theory of Vertical and Lateral Integration

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  • Patrick Legros
  • Andrew F. Newman

Abstract

This article presents a perfectly competitive model of firm boundary decisions and study their interplay with product demand, technology, and welfare. Integration is privately costly but is effective at coordinating production decisions; nonintegration is less costly but coordinates relatively poorly. Output price influences the choice of ownership structure: integration increases with the price level. At the same time, ownership affects output, because integration is more productive than nonintegration. For a generic set of demand functions, equilibrium delivers heterogeneity of ownership and performance among ex ante identical enterprises. The price mechanism transmutes demand shifts into industry-wide reorganizations and generates external effects from technological shocks: productivity changes in some firms may induce ownership changes in others. If the enterprise managers have full title to its revenues, market equilibrium ownership structures are second-best efficient. When managers have less than full revenue claims, equilibrium can be inefficient, with too little integration. JEL Codes: D21, D23, D41, L11, L14, L22. Copyright 2013, Oxford University Press.

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Bibliographic Info

Article provided by Oxford University Press in its journal The Quarterly Journal of Economics.

Volume (Year): 128 (2013)
Issue (Month): 2 ()
Pages: 725-770

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Handle: RePEc:oup:qjecon:v:128:y:2013:i:2:p:725-770

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  1. Schmidt, Klaus M, 1997. "Managerial Incentives and Product Market Competition," Review of Economic Studies, Wiley Blackwell, vol. 64(2), pages 191-213, April.
  2. Oliver Hart & Bengt Holmstrom, 2010. "A Theory of Firm Scope," The Quarterly Journal of Economics, MIT Press, vol. 125(2), pages 483-513, May.
  3. Oliver Hart & John Moore, 1988. "Property Rights and the Nature of the Firm," Working papers 495, Massachusetts Institute of Technology (MIT), Department of Economics.
  4. Conconi, Paola & Legros, Patrick & Newman, Andrew F., 2012. "Trade liberalization and organizational change," Journal of International Economics, Elsevier, vol. 86(2), pages 197-208.
  5. Patrick Legros & Andrew Newman, 1996. "Wealth effects, distribution, and the theory of organization," ULB Institutional Repository 2013/7036, ULB -- Universite Libre de Bruxelles.
  6. Mathias Dewatripont & Patrick Bolton, 2004. "The firm as a communication network," ULB Institutional Repository 2013/9599, ULB -- Universite Libre de Bruxelles.
  7. Eric Van den Steen, 2005. "Organizational Beliefs and Managerial Vision," Journal of Law, Economics and Organization, Oxford University Press, vol. 21(1), pages 256-283, April.
  8. Oliver Hart & John Moore, 1999. "On the Design of Hierarchies: Coordination Versus Specialization," Harvard Institute of Economic Research Working Papers 1880, Harvard - Institute of Economic Research.
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  10. George J. Mailath & Volker Nocke & Andrew Postlewaite, 2004. "Business Strategy, Human Capital, and Managerial Incentives," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 13(4), pages 617-633, December.
  11. de Meza, David & Southey, Clive, 1999. "Too Much Monitoring, Not Enough Performance Pay," Economic Journal, Royal Economic Society, vol. 109(454), pages C126-39, March.
  12. Marianne Bertrand & Sendhil Mullainathan, 2003. "Enjoying the Quiet Life? Corporate Governance and Managerial Preferences," Journal of Political Economy, University of Chicago Press, vol. 111(5), pages 1043-1075, October.
  13. Powell, Ronan & Yawson, Alfred, 2005. "Industry aspects of takeovers and divestitures: Evidence from the UK," Journal of Banking & Finance, Elsevier, vol. 29(12), pages 3015-3040, December.
  14. Oliver Hart & Sanford Grossman, 1985. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Working papers 372, Massachusetts Institute of Technology (MIT), Department of Economics.
  15. Schmidt, Klaus M., 1997. "Managerial Incentives and Product Market Competition," Munich Reprints in Economics 19772, University of Munich, Department of Economics.
  16. Oliver D. Hart, 1983. "The Market Mechanism as an Incentive Scheme," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 366-382, Autumn.
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Cited by:
  1. Paola Conconi & Patrick Legros & Andrew Newman, 2012. "Trade Liberalization and Organizational Change," ULB Institutional Repository 2013/145500, ULB -- Universite Libre de Bruxelles.
  2. Andrew F. Newman & Laura Alfaro & Paola Conconi & Harald Fadinger, 2011. "Trade Policy and Firm Boundaries," Boston University - Department of Economics - Working Papers Series WP2011-035, Boston University - Department of Economics.
  3. Serfes, Konstantinos, 2013. "A Price Theory of Vertical and Lateral Integration under Two-Sided Productivity Heterogeneity," School of Economics Working Paper Series 2013-6, LeBow College of Business, Drexel University, revised 06 Mar 2014.
  4. Simone Moriconi, 2012. "Taxation and Incomplete Contracts," CREA Discussion Paper Series 12-08, Center for Research in Economic Analysis, University of Luxembourg.
  5. Roman Fossati, 2011. "Outsourcing versus Vertical Integration: A Dynamic Model of Industry Equilibrium," 2011 Meeting Papers 1421, Society for Economic Dynamics.
  6. 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.

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