How do firms respond to competition? Evidence from vertical integration

This paper studies whether and how reducing governmental anti-competitive interventions shapes firms' behavior. Using the implementation of the fair competition review system (FCRS) in China as a quasi-natural experiment, which exogenously changes the firms' competitive environment by reducing governmental anti-competitive interventions, we find a significant increase in vertical integration following the FCRS implementation. We further test the mechanisms through which the FCRS affects firms' vertical integration and find that it increases market competition, thereby making vertical integration more desirable. Cross-sectional analyses indicate that vertical integration is more likely to increase when its benefits are higher or its costs are lower. Specifically, this effect is more pronounced among firms with higher industry entry threats, demand risks, lower market positions, greater internal coordination effectiveness, and lower managerial complexity. Our findings suggest that increased local market competition makes vertical integration a desirable strategy for firms seeking a competitive edge in emerging markets.