Contractual Institutions, Financial Development and Vertical Integration: Theory and Evidence

61 Pages Posted: 29 Dec 2006

See all articles by Rocco Macchiavello

Rocco Macchiavello

University of Oxford - Nuffield College of Medicine; Centre for Economic Policy Research (CEPR)

Date Written: October 2006

Abstract

This paper develops an industry equilibrium model of vertical integration under contractual imperfections with specific input suppliers and external investors. I assume that vertical integration economizes on the needs for contracts with specific input suppliers at the cost of higher financial requirements. I show that the two forms of contractual imperfections have different effects on the degree of vertical integration, and that contractual frictions with external investors affect vertical integration through two opposing channels: a direct negative, investment, effect and an indirect positive, entry, effect. Using cross-country-industry data, I present novel evidence on the institutional determinants of international differences in vertical integration which is consistent with the predictions of the theoretical model. In particular, I show that countries with more developed financial systems are relatively more vertically integrated in industries that are dominated by large firms.

Keywords: Vertical integration, credit constraints, contract enforcement, developing countries, industry equilibrium

JEL Classification: D23, L11, L22, O14

Suggested Citation

Macchiavello, Rocco, Contractual Institutions, Financial Development and Vertical Integration: Theory and Evidence (October 2006). CEPR Discussion Paper No. 5903, Available at SSRN: https://ssrn.com/abstract=954125

Rocco Macchiavello (Contact Author)

University of Oxford - Nuffield College of Medicine ( email )

New Road
Oxford, OX1 1NF
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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