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The Cost and Benefits of Ownership: A Theory of Vertical and Lateral Integration

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  • Grossman, Sanford J
  • Hart, Oliver

Abstract

What determines how integrated a firm is? We emphasize the benefits of "control" when there are difficulties in writing complete contracts. We define the firm as being composed of its assets. We present a theory of costly contracts which emphasizes that contractual rights can be of two types: specific rights and residual rights. When it is too costly to list all specific rights over assets in the contract, it may be optimal to let one party purchase all residual rights. Ownership is the purchase of these residual rights. We show that there can be costs associated with the wrong allocation of residual rights.

Suggested Citation

  • 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.
  • Handle: RePEc:cpr:ceprdp:70
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    References listed on IDEAS

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    1. Rubinstein, Ariel, 1982. "Perfect Equilibrium in a Bargaining Model," Econometrica, Econometric Society, vol. 50(1), pages 97-109, January.
    2. Michael Waldman, 1984. "Worker Allocation, Hierarchies and the Wage Distribution," Review of Economic Studies, Oxford University Press, vol. 51(1), pages 95-109.
    3. Sherwin Rosen, 1982. "Authority, Control, and the Distribution of Earnings," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 311-323, Autumn.
    4. Kenneth J. Arrow, 1975. "Vertical Integration and Communication," Bell Journal of Economics, The RAND Corporation, vol. 6(1), pages 173-183, Spring.
    5. Williamson, Oliver E, 1983. "Credible Commitments: Using Hostages to Support Exchange," American Economic Review, American Economic Association, vol. 73(4), pages 519-540, September.
    6. Michael Keren & David Levhari, 1983. "The Internal Organization of the Firm and the Shape of Average Costs," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 474-486, Autumn.
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