A Price Theory of Vertical and Lateral Integration

Elchanan Ben-Porath, Eddie Dekel and Barton L. Lipman

No 2013-004, Boston University - Department of Economics - Working Papers Series from Boston University - Department of Economics

Abstract: This article presents a perfectly-competitive model of firm boundary decisions and study their interplay with product demand, technology, and welfare. Integration is privately costly but is effective at coordinating production decisions; nonintegration is less costly, but coordinates relatively poorly. Output price influences the choice of ownership structure: integration increases with the price level. At the same time, ownership affects output, since integration is more productive than nonintegration. For a generic set of demand functions, equilibrium delivers heterogeneity of ownership and performance among ex-ante identical enterprises. The price mechanism trans- mutes demand shifts into industry-wide re-organizations and generates external effects from technological shocks: productivity changes in some firms may induce ownership changes in others. If the enterprise managers have full title to its revenues, market equilibrium ownership structures are second-best efficient. When managers have less than full revenue claims, equilibrium can be inefficient, with too little integration.

Keywords: Integration; incomplete contracting; market price; organizational welfare loss. (search for similar items in EconPapers)
Pages: 56
Date: 2013-04
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