Boundary of the Firm, Commitment, and R&D Financing

Posted: 26 Jan 1999

See all articles by Haizhou Huang

Haizhou Huang

International Monetary Fund (IMF)

Chenggang Xu

University of Hong Kong

Date Written: July 1999

Abstract

A theory is provided to establish that the allocation of a firm's boundary is conditioned on the financial institutions and on the features of R&D. We show that if a firm does not own a project but finances it externally jointly with other financiers, informational asymmetries and conflicts of interest among co-financiers can be used as a commitment device to stop bad projects; however if a firm owns a project the commitment device will be lost. A general message of our theory is that having a full ownership over an asset may be costly since it can destroy the owner's commitment capacity. But on the other hand, non integration may incur other costs. Thus, at equilibrium with developed financial institutions, large firms do not integrate with high uncertain R&D projects; rather they integrate with low uncertain R&D projects. However, in a financially underdeveloped economy, non integration is often too costly to be chosen regardless of uncertainties of R&D projects.

JEL Classification: O31, O32

Suggested Citation

Huang, Haizhou and Xu, Chenggang, Boundary of the Firm, Commitment, and R&D Financing (July 1999). Available at SSRN: https://ssrn.com/abstract=147452

Haizhou Huang (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

Chenggang Xu

University of Hong Kong ( email )

Pokfulam Road
Hong Kong, Pokfulam HK
China

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