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A Price Theory of Vertical and Lateral Integration

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  • Legros, Patrick
  • Newman, Andrew

Abstract

We construct a price-theoretic model of firms' integration decisions under perfect competition and study their interplay with consumer demand and welfare. Integration is costly to implement but is effective at coordinating production decisions. The price of output influences the ownership structure chosen: there is an inverted-U relation between the degree of integration and product price. Ownership in turn affects output: integration is more productive than non-integration at low prices, and less productive at high prices. If the managers deciding organizational design have full claim to firm revenues, market equilibrium ownership choices will be second-best efficient. When managers have less than a full claim on profits, however, total welfare may sometimes be increased by a social planner who could force some firms to reorganize. The price mechanism tends to correlate reorganizations across firms and generates external effects of technological shocks: productivity changes in some firms may have little effect on their own organization, while inducing changes of ownership in the rest of the industry. Terms of trade in supplier markets also affect ownership structure; entry of low-cost suppliers may induce reorganizations that raise prices. The model can generate coexistence of different ownership structures, even among ex-ante identical firms.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7211.

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Date of creation: Mar 2009
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Handle: RePEc:cpr:ceprdp:7211

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Keywords: decision rights; incomplete contracts; integration; ownership; price theory;

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Cited by:
  1. 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.
  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. Simone Moriconi, 2012. "Taxation and Incomplete Contracts," CREA Discussion Paper Series 12-08, Center for Research in Economic Analysis, University of Luxembourg.
  4. Paola Conconi & Patrick Legros & Andrew F. Newman, 2008. "Trade Liberalization and Organizational Change," Development Working Papers 262, Centro Studi Luca d\'Agliano, University of Milano.
  5. 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.
  6. Roman Fossati, 2012. "Outsourcing versus Vertical Integration: A Dynamic Model of Industry Equilibrium," Bristol Economics Discussion Papers 12/627, Department of Economics, University of Bristol, UK.

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