Come Together: Firm Boundaries and Delegation

Little is known about the relationship between firm boundaries and the allocation of decision rights within firms. We develop a model in which final good producers choose which suppliers to integrate and whether to delegate decisions to integrated suppliers, when they are ex-ante uncertain about their ability. In this setting, integration has an option value: ownership rights give producers authority to delegate or centralize production decisions, depending on the realized ability of suppliers. To assess the evidence, we construct measures of vertical integration and delegation for thousands of firms in many countries and industries. Consistent with the model, we find that (i) integration and delegation co-vary positively; (ii) firms delegate more decisions to integrated suppliers of more valuable inputs; and suppliers are more likely to be integrated if (iii) they produce more valuable inputs and (iv) operate in industries with greater productivity dispersion.