A Price Theory of Vertical and Lateral Integration (Revised Version)

40 Pages Posted: 28 Sep 2012

See all articles by Patrick Legros

Patrick Legros

Université Libre de Bruxelles (ULB) - European Center for Advanced Research in Economics and Statistics (ECARES); Northeastern University, department of economics; Centre for Economic Policy Research (CEPR)

Andrew F. Newman

Boston University - Department of Economics

Date Written: June 2012

Abstract

We present a perfectly-competitive model of firm boundary decisions and study their interplay with product demand, technology, and welfare. Integration is privately costly but is effective at coordinating production decisions; non-integration is less costly, but coordinates relatively poorly. Output price influences the choice of ownership structure: integration increases with the price level. At the same time, ownership affects output, since integration is more productive than non-integration. For a generic set of demand functions, the result is heterogeneity of ownership and performance among ex-ante identical enterprises. The price mechanism transmutes demand shifts into industry-wide reorganizations and generates external effects from technological shocks: productivity changes in some firms may induce ownership changes in others. If the enterprise managers have full title to its revenues, market equilibrium ownership structures are second-best efficient. When managers have less than full revenue claims, equilibrium can be inefficient, with too little integration.

Keywords: decision rights, incomplete contracting, industrial organization, integration, ownership

JEL Classification: D2, D4, L1, L2

Suggested Citation

Legros, Patrick and Newman, Andrew F., A Price Theory of Vertical and Lateral Integration (Revised Version) (June 2012). CEPR Discussion Paper No. DP9004. Available at SSRN: https://ssrn.com/abstract=2153436

Patrick Legros (Contact Author)

Université Libre de Bruxelles (ULB) - European Center for Advanced Research in Economics and Statistics (ECARES) ( email )

Ave. Franklin D Roosevelt, 50 - C.P. 114
Brussels, B-1050
Belgium
+32 2 650 4219/3 (Phone)
+32 2 650 4475 (Fax)

Northeastern University, department of economics ( email )

301 Lake Hall
Boston, MA 02115
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Andrew F. Newman

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States
617-358-4354 (Phone)
617-353-4143 (Fax)

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