Working Paper: NBER ID: w13232
Authors: Sharon Novak; Scott Stern
Abstract: This paper examines complementarity among vertical integration decisions in automobile product development. Though most research assumes that contracting choices are independent of each other, contracting complementarity arises when the returns to a single vertical integration decision are increasing in the level of vertical integration associated with other contracting choices. First, effective coordination may depend on the level of (non-contractible) effort on the part of each agent; contracting complementarity results if coordination efforts are interdependent and vertical integration facilitates a higher level of non-contractible effort. Second, effective coordination may require the disclosure of proprietary trade secrets, and the potential for expropriation by external suppliers may induce complementarity among vertical integration choices. We provide evidence for complementarity in product development contracting by taking advantage of a detailed dataset that includes the level of vertical integration and the contracting environment for individual automobile systems in the luxury automobile segment. Using an instrumental variables framework that distinguishes complementarity from unobserved firm-level factors, the evidence is consistent with the hypothesis that contracting complementarity is an important driver of vertical integration choices. The findings suggest that contracting complementarity may be particularly important when coordination is important to achieve but difficult to monitor.
Keywords: vertical integration; contracting complementarity; automobile product development; coordination; governance choices
JEL Codes: L24; L62; O32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| vertical integration of other systems (L22) | probability of vertical integration for each automobile system (L62) |
| contracting complementarity (D10) | effectiveness of vertical integration decisions (L22) |
| system-specific differences in contracting environments (L14) | contracting complementarity (D10) |