Working Paper: NBER ID: w19727
Authors: James E. Rauch
Abstract: Recently collected data show that, within any manufacturing industry, vertically integrated firms tend to have larger, higher productivity plants, account for the bulk of sales, and also sell externally most of the inputs they produce. In a weak contracting environment characteristic of developing countries, vertically integrated firms are vulnerable to employee "spinouts": managers of input divisions can start their own firms, making customized inputs formerly provided internally subject to hold-up and capturing the profits formerly made from external sales of generic inputs. This vulnerability is shown to lead to inefficiently low entry. Vertically integrated firms can fight back by hiring managers for their input divisions who are members of networks that informally sanction hold-ups or children who keep profits "in the family" even if they spin out. This is shown to predict the association of co-ethnic networks with high rates of entrepreneurship and the prominence of family-owned business groups in developing country manufacturing.
Keywords: employee spinouts; social networks; family firms; vertical integration; entrepreneurship
JEL Codes: L14; L22; L26
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| employee spinouts (M13) | inefficiencies in vertically integrated firms (L22) |
| employee spinouts (M13) | loss of revenue streams for vertically integrated firms (L14) |
| weak contracting environment (L74) | inability to enforce noncompete agreements (L49) |
| inability to enforce noncompete agreements (L49) | significant loss of revenue (H27) |
| employee transition from supplier to independent entrepreneur (L26) | inefficiencies in vertically integrated firms (L22) |
| fear of spinouts (R48) | discouragement of investment in vertically integrated firms (L42) |
| hiring managers from coethnic networks (J15) | mitigate risk of spinouts (R48) |
| coethnic networks (Z13) | enhance stability of firms (G32) |
| social networks (Z13) | higher productivity and larger firm sizes (L25) |