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Firm Reputation and Horizontal Integration

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  • Hongbin Cai
  • Ichiro Obara

Abstract

We study effects of horizontal integration on firm reputation. In an environment where customers observe only imperfect signals about firms' effort/quality choices, firms cannot maintain reputations of high quality and earn quality premium forever. Even when firms are choosing high quality/effort, there is always a possibility that a bad signal is observed. In this case, firms must give up their quality premium, at least temporarily, as punishment. A firm's integration decision is based on the extent to which integration attenuates this necessary cost of maintaining a good reputation. Horizontal integration leads to a larger market base for the merged firm and may allow better monitoring of the firm's choices, hence improving the punishment scheme for deviations. On the other hand, it gives the merged firm more room for sophisticated derivations. We characterize the optimal level of integration and provide sufficient conditions under which nonintegration dominates integration. We show that the optimal size of the firm is smaller when (1) trades are more frequent and information is disseminated more rapidly; or (2) the deviation gain is smaller than the honesty benefit; or (3) customer information about firm choices is more precise.
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Suggested Citation

  • Hongbin Cai & Ichiro Obara, 2008. "Firm Reputation and Horizontal Integration," Levine's Working Paper Archive 122247000000002038, David K. Levine.
  • Handle: RePEc:cla:levarc:122247000000002038
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    References listed on IDEAS

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    Cited by:

    1. Saak, Alexander E., 2016. "Traceability and reputation in supply chains," International Journal of Production Economics, Elsevier, vol. 177(C), pages 149-162.
    2. Chao Yang & Liansheng Wu & Xianhui Bo, 2010. "Career Concern and Tax Preparer Fraud," Annals of Economics and Finance, Society for AEF, vol. 11(2), pages 355-379, November.
    3. Han, Aiping & Ge, Jianping & Lei, Yalin, 2016. "Vertical vs. horizontal integration: Game analysis for the rare earth industrial integration in China," Resources Policy, Elsevier, vol. 50(C), pages 149-159.
    4. Alexander E. Saak, 2012. "Collective Reputation, Social Norms, and Participation," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 94(3), pages 763-785.
    5. Du, Chuang, 2012. "Solving payoff sets of perfect public equilibria: an example," MPRA Paper 38622, University Library of Munich, Germany.
    6. Eric Rasmusen, 2011. "Leveraging of Reputation Through Umbrella Branding with and Without Market Power," Working Papers 2011-07, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
    7. repec:bla:jindec:v:65:y:2017:i:2:p:309-335 is not listed on IDEAS
    8. Hongbin Cai & Ichiro Obara, 2009. "Firm reputation and horizontal integration," RAND Journal of Economics, RAND Corporation, vol. 40(2), pages 340-363.
    9. Fishman, Arthur, 2009. "Financial intermediaries as facilitators of information exchange between lenders and reputation formation by borrowers," International Review of Economics & Finance, Elsevier, vol. 18(2), pages 301-305, March.
    10. Cabral, Luís M.B., 2009. "Umbrella branding with imperfect observability and moral hazard," International Journal of Industrial Organization, Elsevier, vol. 27(2), pages 206-213, March.
    11. Hakenes, Hendrik & Peitz, Martin, 2009. "Umbrella branding and external certification," European Economic Review, Elsevier, vol. 53(2), pages 186-196, February.
    12. Luis M. B. Cabral, 2001. "Optimal Brand Umbrella Size," Working Papers 01-06, New York University, Leonard N. Stern School of Business, Department of Economics.
    13. repec:eee:indorg:v:59:y:2018:i:c:p:316-339 is not listed on IDEAS
    14. Fishman, Arthur & Finkelshtain, Israel & Simhon, Avi & Yacouel, Nira, 2008. "The Economics of Collective Brands," Discussion Papers 46056, Hebrew University of Jerusalem, Department of Agricultural Economics and Management.
    15. Saak, Alexander E., 2015. "Delegation of Monitoring, Transparency, and Reputation," 2015 AAEA & WAEA Joint Annual Meeting, July 26-28, San Francisco, California 205682, Agricultural and Applied Economics Association.
    16. Saak, Alexander E., 2016. "Delegation of quality control in value chains:," IFPRI discussion papers 1526, International Food Policy Research Institute (IFPRI).
    17. Kobayashi, Hajime & Ohta, Katsunori, 2012. "Optimal collusion under imperfect monitoring in multimarket contact," Games and Economic Behavior, Elsevier, vol. 76(2), pages 636-647.
    18. Daniel Goetz, 2017. "Competition and Product Misrepresentation," Working Papers 17-03, NET Institute.

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