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A Price Theory of Vertical and Lateral Integration

  • Legros, Patrick
  • Newman, Andrew

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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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7211.

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Date of creation: Mar 2009
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Handle: RePEc:cpr:ceprdp:7211
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  1. Patrick Bolton & Michael D. Whinston, 1993. "Incomplete Contracts, Vertical Integration, and Supply Assurance," Review of Economic Studies, Oxford University Press, vol. 60(1), pages 121-148.
  2. Hart, Oliver D. & Moore, John, 1990. "Property Rights and the Nature of the Firm," Scholarly Articles 3448675, Harvard University Department of Economics.
  3. 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.
  4. Oliver Hart & John Moore, 1999. "On the Design of Hierarchies: Coordination Versus Specialization," Harvard Institute of Economic Research Working Papers 1880, Harvard - Institute of Economic Research.
  5. Van den Steen, Eric, 2003. "Organizational Beliefs and Managerial Vision," Working papers 4224-01, Massachusetts Institute of Technology (MIT), Sloan School of Management.
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  8. Patrick Legros & Andrew Newman, 1996. "Wealth effects, distribution, and the theory of organization," ULB Institutional Repository 2013/7036, ULB -- Universite Libre de Bruxelles.
  9. 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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  14. repec:oup:restud:v:64:y:1997:i:2:p:191-213 is not listed on IDEAS
  15. Marianne Bertrand & Sendhil Mullainathan, 2003. "Enjoying the Quiet Life? Corporate Governance and Managerial Preferences," Journal of Political Economy, University of Chicago Press, vol. 111(5), pages 1043-1075, October.
  16. Fama, Eugene F & Jensen, Michael C, 1983. "Separation of Ownership and Control," Journal of Law and Economics, University of Chicago Press, vol. 26(2), pages 301-25, June.
  17. de Meza, David & Southey, Clive, 1999. "Too Much Monitoring, Not Enough Performance Pay," Economic Journal, Royal Economic Society, vol. 109(454), pages C126-39, March.
  18. Radner, Roy, 1993. "The Organization of Decentralized Information Processing," Econometrica, Econometric Society, vol. 61(5), pages 1109-46, September.
  19. Oliver Hart & Bengt Holmstrom, 2008. "A Theory of Firm Scope," NBER Working Papers 14613, National Bureau of Economic Research, Inc.
  20. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-29, May.
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  22. Mitchell, Mark L. & Mulherin, J. Harold, 1996. "The impact of industry shocks on takeover and restructuring activity," Journal of Financial Economics, Elsevier, vol. 41(2), pages 193-229, June.
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