Foreclosure with Incomplete Information

Abstract

We investigate the robustness of the new foreclosure doctrine and its associated welfare implications to the introduction of incomplete information. In particular, we let the upstream firm's marginal cost be private information, unknown to the downstream firms. The previous literature has argued that vertical integration is harmful because it allows an upstream monopolist to limit output to monopoly levels, whereas a disintegrated structure will 'over-sell', producing more in equilibrium. By contrast, we find that with incomplete information, high-cost firms will often 'under-sell' in equilibrium; that is, supply less than their monopoly output. Low-cost firms continue to over-sell, so all types of firms have a reason to integrate downstream, but this is socially harmful only for low-cost types. For high-cost firms vertical integration can be Pareto-improving, resulting in higher output, profits and consumer surplus.

Keywords: Foreclosure, vertical integration, asymmetric information

JEL Classification: D42, D82, L12, L42