Financial Constraints and the Costs and Benefits of Vertical Integration

49 Pages Posted: 14 May 2008

See all articles by Rocco Macchiavello

Rocco Macchiavello

University of Oxford - Nuffield College of Medicine; Centre for Economic Policy Research (CEPR)

Date Written: February 2007

Abstract

Does vertical integration reduce or increase transaction costs with external investors? This paper analyzes an incomplete contracts model of vertical integration in which a seller and a buyer with no cash need to finance investments for production. The firm is modeled as a nexus of contracts across the intermediate input supply and the financing transaction. The costs and benefits of vertical integration depend on the relative importance of a positive contractual centralization effect against a negative de-monitoring effect: the firm centrally organizes the nexus of contracts reducing the extent of contractual externalities while the market disciplines decisions driven by private benefits. Larger projects, more specific assets, and low investors protection are determinants of vertical integration.

Keywords: Contractual externalities, investors protection, limited liability, theory of the firm, vertical integration

JEL Classification: D23, G32, K12, L22, O10

Suggested Citation

Macchiavello, Rocco, Financial Constraints and the Costs and Benefits of Vertical Integration (February 2007). CEPR Discussion Paper No. DP6104, Available at SSRN: https://ssrn.com/abstract=1132241

Rocco Macchiavello (Contact Author)

University of Oxford - Nuffield College of Medicine ( email )

New Road
Oxford, OX1 1NF
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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