Vertical integration, knowledge disclosure and decreasing rival's cost

We study vertical integration incorporating the fact that it creates the possibility of knowledge disclosure. We consider a setting where, through integrating, an upstream monopolist learns its downstream partner’s innovation, and can disclose it to its downstream rival. We show that a vertically integrated firm chooses to fully disclose its knowledge to its downstream rival. Knowledge disclosure intensifies downstream competition but, at the same time, expands the downstream market size. We also show that, due to knowledge disclosure, vertical integration increases firms’ innovation incentives, consumer and total welfare, and decreases, instead of raises, the rival’s cost.