How Vertical Integration Affects Firm Innovation: Quasi-Experimental Evidence

Abstract

Although it is well established that vertical integration decisions have important consequences for firms, direct evidence on how vertical integration matters to firm innovation has been scarce. This study draws from seminal research on organizing for innovation and recent synthesis of transaction cost and capabilities theories to examine how vertical integration affects the rate and types of firm innovation pursued. To strengthen identification of causal effects, we exploit a quasi-experimental design to compare firms that announced and completed a vertical merger and acquisition (M&A) with those announcing but not completing the transaction. We show that firms completing vertical M&As experience a growth in their rate of innovation; in addition, such firms witness an increase in systemic innovation but a drop in autonomous innovation. Our study contributes important empirical evidence to bear on the literature on the organization of innovation, highlighting that organizational mode choices are a critical determinant of the rate and direction of inventive activity.