Endogenous Property Rights and the Nature of the Firm
44 Pages Posted: 15 Apr 2020 Last revised: 13 Aug 2020
Date Written: June 30, 2020
While focusing on residual rights, the property rights theory---i.e., PRT---of the firm overlooks the legal protection of each party's input. We assume, instead, that the legislator selects the upstream firms' property rights, which, in turn, determine their ex post bargaining power, by maximizing the supply of projects possibly adopting the efficient full-investment profile and, conditionally on this goal being reached, minimizing less likely deviations to inefficient intermediate-investment profiles. Different from the PRT, each party's ex ante incentives are exclusively determined by property rights, which are, in turn, entirely driven by the---absolute and relative to innovation costs---size of the default payoffs. When the latter are small and, thus, the gains from trade are large, any market structure delivers the same incentives for full-investment. Then, the legislator's goal becomes discouraging costly deviations by unbalancing the most the parties' investment returns. To do so, she protects more the party with the smallest default payoff in such a way that the other one receives more often its preferred ownership structure. Opposite patterns arise when the investment returns are already unbalanced by one disagreement payoff being large and, thus, fostering full-investment is pivotal. Regardless of the relative size of the innovation costs, each party's property rights are weaker (stronger) the larger its (partner's) default payoff is. These links remain true when one party dominates institutional design or has a stronger impact on the project value. In the last case, property rights do not generally favor the party shaping the most the relationship value. Crucially, our conclusions are consistent with the interplay among proxies for the legal protection of the downstream firms' personal and intellectual property, firms' presence in the value chain, process and capital specificity and R\&D intensity in a panel of 119 countries spanning the 2006-2018 period.
Keywords: Property rights; Vertical integration; Asset specificity; Bargaining
JEL Classification: D23; D86; L24; D02
Suggested Citation: Suggested Citation