Working Paper: CEPR ID: DP5903
Authors: Rocco Macchiavello
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: Contract enforcement; Credit constraints; Developing countries; Industry equilibrium; Vertical integration
JEL Codes: D23; L11; L22; O14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Contractual imperfections (D86) | vertical integration (L22) |
| Financial market imperfections (G19) | vertical integration (L22) |
| Financial market imperfections (G19) | new entrants (M13) |