Vertical Integration and Distance to Frontier
16 Pages Posted: 1 Nov 2002
Date Written: October 2002
We construct a model where the equilibrium organization of firms changes as an economy approaches the world technology frontier. In vertically integrated firms, owners (managers) have to spend time both on production and innovation activities, and this creates managerial overload, and discourages innovation. Outsourcing of some production activities mitigates the managerial overload, but creates a holdup problem, causing some of the rents of the owners to be dissipated to the supplier. Far from the technology frontier, imitation activities are more important, and vertical integration is preferred. Closer to the frontier, the value of innovation increases, encouraging outsourcing.
Keywords: Economic growth, contracts, internal organization of the firm, vertical integration
JEL Classification: L16, L22, O31, O33, O38, O40
Suggested Citation: Suggested Citation