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Vertical Integration, Missing Middle and Investor Protection in Developing Countries

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  • Rocco Macchiavello

Abstract

The industrial organization of developing countries is characterized by: (i) pervasive use of subcontracting arrangements among small firms, (ii) "missing middle" in the firm size distribution, and (iii) financially constrained firms. This paper studies an incomplete contract model in which the integration decision is chosen to maximize the returns of two vertically related projects to an external investor. The model jointly determines the financing, size and organization of firms. Vertical integration trades-off the benefits of joint liability against the cost of rendering the supply chain more opaque from the point of view of investors. The model shows that vertical integration is more likely to arise for intermediate levels of investor protection and that better contract enforcement reduces vertical integration only if financial markets are sufficiently developed. Moreover, the firm size distribution is more likely to display a missing middle in industries which favor vertical integration. The model sheds light on the industrial organization of developing countries showing that the motives for vertical integration are not necessarily higher in those countries.

Suggested Citation

  • Rocco Macchiavello, 2007. "Vertical Integration, Missing Middle and Investor Protection in Developing Countries," Economics Series Working Papers 373, University of Oxford, Department of Economics.
    • Handle: RePEc:oxf:wpaper:373
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • O12 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Microeconomic Analyses of Economic Development
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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