Monday, May 20, 2013
Posted by D. Daniel Sokol
Laurent Fresard, University of Maryland - Robert H. Smith School of Business, Gerard Hoberg, University of Maryland - Department of Finance and Gordon M. Phillips, University of Southern California describe The Incentives for Vertical Mergers and Vertical Integration.
ABSTRACT: We examine the incentives for firms to vertically integrate through vertical mergers and production. We develop a new firm-specific measure of vertical integration using 10-K text to identify the extent a firm's products span vertically related product markets. We find that firms in high R&D industries are less likely to vertically integrate or engage in vertical mergers, and are more likely to initiate customer or supplier relationships outside of the firm. These findings are consistent with firms with unrealized innovation avoiding integration to maintain ex ante incentives to make relationship specific investments and maintain residual rights of control as in Grossman and Hart (1986). In contrast, firms in high patenting industries with stable product markets are more likely to vertically integrate consistent with control rights being obtained by firms to facilitate commercialization of already realized innovation.