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Financial Constraints and the Costs and Benefits of Vertical Integration

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Author Info
Macchiavello, Rocco

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Abstract

Does vertical integration reduce or increase transaction costs with external investors? This paper analyzes an incomplete contracts model of vertical integration in which a seller and a buyer with no cash need to finance investments for production. The firm is modeled as a "nexus of contracts" across the intermediate input supply and the financing transaction. The costs and benefits of vertical integration depend on the relative importance of a positive "contractual centralization" effect against a negative "de-monitoring" effect: the firm centrally organizes the nexus of contracts reducing the extent of contractual externalities while the market disciplines decisions driven by private benefits. Larger projects, more specific assets, and low investors protection are determinants of vertical integration.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6104.

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Date of creation: Feb 2007
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Handle: RePEc:cpr:ceprdp:6104

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Related research
Keywords: contractual externalities investors protection limited liability theory of the firm vertical integration

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Find related papers by JEL classification:
D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure
K12 - Law and Economics - - Basic Areas of Law - - - Contract Law
L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
O10 - Economic Development, Technological Change, and Growth - - Economic Development - - - General

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