Vertical Integration with Two-sided Heterogeneity and Firm-to-firm Network Structure of Production

We study the overlap of the production and ownership relationships between firms in Japan. We leverage data of unprecedented coverage to document the economy-wide incidence of vertical integration and to study the importance of customer and supplier networks for the organization of production relationships. We develop a property-rights-theory model of organizational choice within a production network that features two-sided heterogeneity and a market for corporate control, in which firms compete for the ownership of common suppliers and customers. In line with the predictions of our model, we find that firms that are large, but have fewer, smaller, and less capital-intensive customers and suppliers are more likely to be vertically integrated. Moreover, these targets are likely to be integrated by the largest customer/supplier within their network.