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Firm Reputation and Horizontal Integration

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  • Cai, Hongbin

Abstract

We study effects of horizontal integration on firm reputation. In an environment where customers observe only imperfect signals about firms' effort/quality choices, firms cannot maintain reputations of high quality and earn quality premium forever. Even when firms are choosing high quality/effort, there is always a possibility that a bad signal is observed. In this case, firms must give up their quality premium, at least temporarily, as punishment. A firm's integration decision is based on the extent to which integration attenuates this necessary cost of maintaining a good reputation. Horizontal integration leads to a larger market base for the merged firm and may allow better monitoring of the firm's choices, hence improving the punishment scheme for deviations. On the other hand, it gives the merged firm more room for sophisticated derivations. We characterize the optimal level of integration and provide sufficient conditions under which nonintegration dominates integration. We show that the optimal size of the firm is smaller when (1) trades are more frequent and information is disseminated more rapidly; or (2) the deviation gain is smaller than the honesty benefit; or (3) customer information about firm choices is more precise.

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Bibliographic Info

Paper provided by Department of Economics, UC Santa Cruz in its series Santa Cruz Department of Economics, Working Paper Series with number qt6rk9f1fm.

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Date of creation: 01 Oct 2004
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Handle: RePEc:cdl:ucscec:qt6rk9f1fm

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References

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  1. Drew Fudenberg & David K. Levine & Eric Maskin, 1994. "The Folk Theorem with Imperfect Public Information," Levine's Working Paper Archive 394, David K. Levine.
  2. Arthur Fishman & Rafael Rob, 2002. "Is Bigger Better? Investing in Reputation," Penn CARESS Working Papers 40893328535d25cf3e69a981a, Penn Economics Department.
  3. Hongbin Cai & Ichiro Obara, 2006. "Firm Reputation and Horizontanl Integration," Levine's Bibliography 321307000000000285, UCLA Department of Economics.
  4. Klein, Benjamin & Leffler, Keith B, 1981. "The Role of Market Forces in Assuring Contractual Performance," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 615-41, August.
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  23. Radner, Roy, 1985. "Repeated Principal-Agent Games with Discounting," Econometrica, Econometric Society, vol. 53(5), pages 1173-98, September.
  24. Ginger Zhe Jin & Phillip Leslie, 2009. "Reputational Incentives for Restaurant Hygiene," American Economic Journal: Microeconomics, American Economic Association, vol. 1(1), pages 237-67, February.
  25. Andersson, Fredrik, 2002. "Pooling reputations," International Journal of Industrial Organization, Elsevier, vol. 20(5), pages 715-730, May.
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Citations

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Cited by:
  1. Saak, Alexander E., 2013. "Traceability and Reputation in Supply Chains," 2013 Annual Meeting, August 4-6, 2013, Washington, D.C. 149988, Agricultural and Applied Economics Association.
  2. Hendrik Hakenes & Martin Peitz, 2008. "Umbrella Branding and External Certification," Working Paper Series of the Max Planck Institute for Research on Collective Goods 2008_10, Max Planck Institute for Research on Collective Goods.
  3. Du, Chuang, 2012. "Solving payoff sets of perfect public equilibria: an example," MPRA Paper 38622, University Library of Munich, Germany.
  4. Cabral, Luís M.B., 2009. "Umbrella branding with imperfect observability and moral hazard," International Journal of Industrial Organization, Elsevier, vol. 27(2), pages 206-213, March.
  5. Hongbin Cai & Ichiro Obara, 2006. "Firm Reputation and Horizontanl Integration," Levine's Bibliography 321307000000000285, UCLA Department of Economics.
  6. Saak, Alexander, 2011. "Collective reputation, social norms, and participation:," IFPRI discussion papers 1107, International Food Policy Research Institute (IFPRI).
  7. Kobayashi, Hajime & Ohta, Katsunori, 2012. "Optimal collusion under imperfect monitoring in multimarket contact," Games and Economic Behavior, Elsevier, vol. 76(2), pages 636-647.
  8. Eric Rasmusen, 2011. "Leveraging of Reputation Through Umbrella Branding with and Without Market Power," Working Papers 2011-07, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  9. Fishman, Arthur & Finkelshtain, Israel & Simhon, Avi & Yacouel, Nira, 2008. "The Economics of Collective Brands," Discussion Papers 46056, Hebrew University of Jerusalem, Department of Agricultural Economics and Management.
  10. Chao Yang & Liansheng Wu & Xianhui Bo, 2010. "Career Concern and Tax Preparer Fraud," Annals of Economics and Finance, Society for AEF, vol. 11(2), pages 355-379, November.
  11. Fishman, Arthur, 2009. "Financial intermediaries as facilitators of information exchange between lenders and reputation formation by borrowers," International Review of Economics & Finance, Elsevier, vol. 18(2), pages 301-305, March.

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