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

Rocco Macchiavello ()

No 5903, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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 (search for similar items in EconPapers)
JEL-codes: D23 L11 L22 O14 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-com and nep-dev
Date: 2006-10
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