The Value of Interlocking Directorates in Vertical Contracting

Abstract

This study analyzes the choice to interlock between two competing companies when their privately known marginal costs are correlated. The two rivals are organized into different business models: one delegates its production to a subcontractor, while the other is vertically integrated and carries its production in-house. By accepting the interlock, the hosting company discloses its marginal cost to the rival. The two companies decide ex-ante whether to commit to interlock. In a Perfect Bayesian Equilibrium, the vertically separated company gains more from interlocking than the rival because it saves on internal agency costs and gains market power, otherwise unbalanced toward the competitor. Interestingly, we show the following: for high-cost correlation allowing a unilateral interlock benefits consumers. Hence, our results provide reasons for approving horizontal interlocking in markets where companies have asymmetric business models, and the interlocking company outsources its production.

Keywords: Interlocking directorates; Agency costs; Vertical hierarchy

JEL Classification: D43, D82, D83, L2