Incomplete Contracts, Vertical Integration, and Supply Assurance

Abstract

This paper extends the analysis of transactions cost models of vertical integration to multilateral settings. Its main focus is on supply assurance concerns which arise when several downstream firms are competing for inputs in limited supply. Integration reduces supply assurance concerns for an integrating firm but it may increase them for others. Therefore, to explain the scope of any firm, one must consider the overall network of production and distribution relations. Three fundamental questions are addressed: (1) What are the effects of different integration structures?; (2) What are the determinants of the socially efficient integration structures?; (3) In what way do equilibrium integration structures differ from socially efficient structures?