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Do Prices Determine Vertical Integration? Evidence from Trade Policy

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  • Alfaro, Laura
  • Conconi, Paola
  • Fadinger, Harald
  • Newman, Andrew

Abstract

This paper shows that product prices determine organizational design by studying how trade policy affects vertical integration. Property rights theory asserts that firm boundaries are chosen by stakeholders to mediate organizational goals (e.g., profits) and private benefits (e.g., operating in preferred ways). We present an incomplete-contracts model in which vertical integration raises output at the expense of lower private benefits. A key implication is that higher prices should result in more integration, since the organizational goal becomes relatively more valuable than private benefits. Trade policy provides a source of exogenous price variation to test this proposition: higher tariffs should lead to more vertical integration; moreover, ownership structures should be more alike across countries with similar levels of protection. To assess the evidence, we construct firm-level indices of vertical integration for a large set of countries and industries and exploit cross-section and time-series variation in import tariffs to examine the impact of prices on organizational choices. Our empirical results provide strong support for the predictions of the model.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9200.

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Date of creation: Oct 2012
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Handle: RePEc:cpr:ceprdp:9200

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Related research

Keywords: incomplete contracts; organizational IO; property rights theory; theory of the firm; vertical integration;

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Cited by:
  1. Buehler, Stefan & Burghardt, Dirk, 2013. "Globalization and Vertical Structure: An Empirical Investigation," Economics Working Paper Series 1310, University of St. Gallen, School of Economics and Political Science.
  2. 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.

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