Endogenous Property Rights and the Nature of the Firm

Abstract

While focusing on residual rights, the property rights theory---i.e., PRT---of the firm overlooks the role of the legal environment. We assume, instead, that society selects the upstream firms' property rights, which, in turn, determine their ex post bargaining power, by maximizing the possible adoption of the efficient full-investment profile and, conditional on this goal being reached, minimizing less likely deviations to the inefficient intermediate-investment profiles. Three are the key model implications, which, in turn, differ from the PRT's conclusions. First, the strength of a party's property rights negatively affects the intensity of its residual rights, exclusively determines its incentives to undertake ex ante non-contractible specific investments and is entirely driven by the---absolute and relative to innovation costs---size of the default payoffs. Second, to incentivize full-investment, society tends to protect less (more) a firm's property rights when its (partner's) default payoff under its preferred ownership structure is larger and does not favor the party affecting the most the relationship value. Finally, the extent of integration weakly falls with both the marginal innovation cost and the default payoffs. Crucially, these predictions remain true when one group of firms dominates institutional design and are consistent with the interplay among proxies for the legal protection of the downstream firms' personal and intellectual property, firms' presence in the value chain, process and capital specificity and R\&D intensity for 119 countries over the 2006-2018 period.