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On Synergies and Vertical Integration

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  • Schmitz, Patrick
  • Dirk Sliwka

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

Paper provided by University of Bonn, Germany in its series Discussion Paper Serie A with number 602.

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Date of creation: Jul 1999
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Handle: RePEc:bon:bonsfa:602

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Postal: Bonn Graduate School of Economics, University of Bonn, Adenauerallee 24 - 26, 53113 Bonn, Germany
Fax: +49 228 73 6884
Web page: http://www.bgse.uni-bonn.de

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Keywords: Synergies; Vertical Integration; Incomplete Contracts; Hold-Up; Specialization;

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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. 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.
  3. 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.
  4. Rosenkranz, Stephanie & Schmitz, Patrick W., 1999. "Know-how disclosure and incomplete contracts," MPRA Paper 12533, University Library of Munich, Germany.
  5. Raghuram G. Rajan & Luigi Zingales, . "Power in a Theory of the Firm," CRSP working papers 335, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  6. Maskin, Eric & Tirole, Jean, 1999. "Two Remarks on the Property-Rights Literature," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 139-49, January.
  7. Moore, John & Repullo, Rafael, 1988. "Subgame Perfect Implementation," Econometrica, Econometric Society, vol. 56(5), pages 1191-1220, September.
  8. Williams, I., 1996. "Integration and investment specificity," Discussion Paper Series In Economics And Econometrics 9614, Economics Division, School of Social Sciences, University of Southampton.
  9. Oliver Hart & John Moore, 1998. "Foundations of Incomplete Contracts," Harvard Institute of Economic Research Working Papers 1846, Harvard - Institute of Economic Research.
  10. Donald B. Hausch & Yeon-Koo Che, 1999. "Cooperative Investments and the Value of Contracting," American Economic Review, American Economic Association, vol. 89(1), pages 125-147, March.
  11. Hart, Oliver & Moore, John, 1990. "Property Rights and the Nature of the Firm," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1119-58, December.
  12. Yang, Xiaokai & Ng, Yew-Kwang, 1995. "Theory of the firm and structure of residual rights," Journal of Economic Behavior & Organization, Elsevier, vol. 26(1), pages 107-128, January.
  13. Jean Tirole, 1999. "Incomplete Contracts: Where Do We Stand?," Econometrica, Econometric Society, vol. 67(4), pages 741-782, July.
  14. Chiu, Y Stephen, 1998. "Noncooperative Bargaining, Hostages, and Optimal Asset Ownership," American Economic Review, American Economic Association, vol. 88(4), pages 882-901, September.
  15. Moore, John, 1992. "The firm as a collection of assets," European Economic Review, Elsevier, vol. 36(2-3), pages 493-507, April.
  16. Rotemberg, Julio J & Saloner, Garth, 1994. "Benefits of Narrow Business Strategies," American Economic Review, American Economic Association, vol. 84(5), pages 1330-49, December.
  17. Holmstrom, Bengt & Tirole, Jean, 1991. "Transfer Pricing and Organizational Form," Journal of Law, Economics and Organization, Oxford University Press, vol. 7(2), pages 201-28, Fall.
  18. Maskin, Eric & Tirole, Jean, 1999. "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 83-114, January.
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Citations

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Cited by:
  1. Herbst, Patrick & Walz, Uwe, 2009. "The design of vertical R&D collaborations," CFS Working Paper Series 2009/06, Center for Financial Studies (CFS).
  2. Richter, Alexander, 2010. "Industrielle Produkt-Service-Systeme: Eine vertragstheoretische Analyse," Arbeitsberichte des Lehrstuhls für Produktionswirtschaft 9, Ruhr-Universität Bochum (RUB), Lehrstuhl für Produktionswirtschaft.
  3. Schmitz, Patrick W., 2005. "Information Gathering, Transaction Costs and the Property Rights Approach," CEPR Discussion Papers 5417, C.E.P.R. Discussion Papers.
  4. Sliwka, Dirk, 2003. "Management Incentives, Signaling Effects and the Costs of Vertical Integration," IZA Discussion Papers 856, Institute for the Study of Labor (IZA).
  5. 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.
  6. 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.
  7. Patrick W. Schmitz, 2000. "Partial Privatization and Incomplete Contracts: The Proper Scope of Government Reconsidered," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 57(4), pages 394-411, August.
  8. Oberg, Christina & Holtstrom, Johan, 2006. "Are mergers and acquisitions contagious?," Journal of Business Research, Elsevier, vol. 59(12), pages 1267-1275, November.
  9. 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).
  10. 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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