Abstract
We develop a new theory of the dynamic boundary of the firm where asset owners may want to change partners ex-post. The model identifies a fundamental trade-off between (i) a externality under non-integration, where a partner leaves a relationship even though his benefit is worth less than the loss to the displaced partner, and (ii) a externality under integration, where a partner inefficiently retains the other. With more asset specificity, displacement externalities matter more and retention externalities less, so that integration becomes more attractive. Our model also shows that wealthy partners would want to commit to ex-post wealth constraints.
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