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A Price Theory of Vertical and Lateral Integration

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  • Patrick Legros
  • Andrew Newman

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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Bibliographic Info

Paper provided by ULB -- Universite Libre de Bruxelles in its series ULB Institutional Repository with number 2013/141436.

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Date of creation: 2013
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Publication status: Forthcoming
Handle: RePEc:ulb:ulbeco:2013/141436

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References

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  1. Oliver Hart & John Moore, 1999. "On the design of hierarchies: coordination versus specialization," LSE Research Online Documents on Economics 19340, London School of Economics and Political Science, LSE Library.
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  10. Grossman, Sanford J & Hart, Oliver, 1985. "The Cost and Benefits of Ownership: A Theory of Vertical and Lateral Integration," CEPR Discussion Papers 70, C.E.P.R. Discussion Papers.
  11. Andrew F. Newman & Patrick Legros & Paola Conconi, 2011. "Trade Liberalization and Organizational Change," Boston University - Department of Economics - Working Papers Series WP2011-037, Boston University - Department of Economics.
  12. Schmidt, Klaus M., 1997. "Managerial Incentives and Product Market Competition," Munich Reprints in Economics 19772, University of Munich, Department of Economics.
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Citations

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Cited by:
  1. 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.
  2. Conconi, Paola & Legros, Patrick & Newman, Andrew, 2008. "Trade Liberalization and Organizational Change," CEPR Discussion Papers 7028, C.E.P.R. Discussion Papers.
  3. 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.
  4. Román Fossati, 2012. "Outsourcing versus vertical integration: A dynamic model of industry equilibrium," Working Papers, Instituto Madrileño de Estudios Avanzados (IMDEA) Ciencias Sociales 2012-07, Instituto Madrileño de Estudios Avanzados (IMDEA) Ciencias Sociales.
  5. 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.
  6. Simone Moriconi, 2012. "Taxation and Incomplete Contracts," CREA Discussion Paper Series 12-08, Center for Research in Economic Analysis, University of Luxembourg.

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