The Role of Transaction Costs on Vertical Integration and Innovation: A General Equilibrium Approach

Abstract

The traditional transaction cost perspective helps us understand how governance structures impact dyadic transaction costs by focusing on the possibility of ex-post holdup, but it usually neglects the impact of such decisions on other agents. This paper uses value capture theory to investigate how vertical integration impacts the firm’s ability to extract rents from other agents in the market. Integration solves the ex-post holdup costs within a dyad, causing an increase in the integrated firm’s ability to appropriate value from other firms. This higher bargaining ability makes independent firms less willing to share information with the integrated organization. Thus, by studying all agents in the market, the paper demonstrates one endogenous cost of vertical integration by showing that integration inflicts an informational cost.

Keywords: transaction cost, knowledge tranfer, value capture, vertical integraiton

JEL Classification: D23, D83, L22