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Contractual Institutions, Financial Development and Vertical Integration: Theory and Evidence

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  • Macchiavello, Rocco

Abstract

This paper develops an industry equilibrium model of vertical integration under contractual imperfections with specific input suppliers and external investors. I assume that vertical integration economizes on the needs for contracts with specific input suppliers at the cost of higher financial requirements. I show that the two forms of contractual imperfections have different effects on the degree of vertical integration, and that contractual frictions with external investors affect vertical integration through two opposing channels: a direct negative, investment, effect and an indirect positive, entry, effect. Using cross-country-industry data, I present novel evidence on the institutional determinants of international differences in vertical integration which is consistent with the predictions of the theoretical model. In particular, I show that countries with more developed financial systems are relatively more vertically integrated in industries that are dominated by large firms.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5903.

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Date of creation: Oct 2006
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Handle: RePEc:cpr:ceprdp:5903

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Keywords: contract enforcement; credit constraints; developing countries; industry equilibrium; vertical integration;

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Citations

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Cited by:
  1. Macchiavello, Rocco, 2010. "Vertical integration and investor protection in developing countries," Journal of Development Economics, Elsevier, vol. 93(2), pages 162-172, November.
  2. Luigi Pascali, 2009. "Contract Incompleteness, Globalization and Vertical Structure: an Empirical Analysis," Boston College Working Papers in Economics 727, Boston College Department of Economics.
  3. Rocco Macchiavello, 2007. "Vertical Integration, Missing Middle and Investor Protection in Developing Countries," Economics Series Working Papers 373, University of Oxford, Department of Economics.
  4. Macchiavello, Rocco, 2007. "Financial Constraints and the Costs and Benefits of Vertical Integration," CEPR Discussion Papers 6104, C.E.P.R. Discussion Papers.

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