Economic Policy Uncertainty and Vertical Integration: An Analysis from the Perspective of Supply Chain

Abstract

During recent years, global economic uncertainty has risen sharply. The effect of economic policy uncertainty on business activities has become a research hotspot in academia, while previous studies mainly focus on the independent individuals of companies. It is considered that companies are closely related with others from upstream and downstream industries, thereby market transaction costs significantly influence the survival and development of companies, especially in the presence of high economic policy uncertainty. Therefore, this paper explores the impact of economic policy uncertainty on vertical integration from the perspective of supply chain. Vertical integration is defined that companies control adjacent production stages vertically on the supply chain, internalizing transactions between external companies into internal production activities.To be specific, using a sample of listed companies from manufacturing industry during 2000-2018 in China, as well as the vertical integration indicator manually sorted out and calculated, this paper investigates the effect of economic policy uncertainty on vertical integration. The result shows that the higher economic policy uncertainty is, the more inclined companies are to pursue vertical integration. The robustness test and instrumental variable estimation show that this basic result is valid and robust. The heterogeneity analysis conducted at firm-, industry-, and region-level shows that for non-state-owned companies, companies with higher asset specificity, and companies from high-tech industries, more competitive industries, more volatile industries, and the eastern region, the effect of economic policy uncertainty on vertical integration is greater. Further, this paper explores the mechanism about how economic policy uncertainty influences vertical integration. The result shows that economic policy uncertainty significantly decreases the investment intensity of upstream suppliers and downstream distributors, and leads to higher financing constraints, thereby inducing the propensity of vertical integration. More than that, this paper analyzes the reason why economic policy uncertainty has a greater impact on upstream industries from three perspectives: government regulations on the upstream and downstream industries, the proportion of state-owned enterprises distributed in upstream and downstream industries, and the capital intensity of upstream and downstream industries.This paper has the following contributions: From the perspective of supply chain, it explores the impact of economic policy uncertainty on micro enterprise operation; from the perspective of economic policy uncertainty, it enriches the research on the influencing factors of vertical integration, and provides new empirical evidence from China’s manufacturing industry. In addition, from the perspective of supply chain management, this paper provides policy recommendations and management implications for local governments and enterprises to deal with emergencies and the resulting economic policy uncertainty.