The missing option in firm boundary decisions

Abstract

Abstract Integration involves two firms, the integrating firm and the integrated firm. This paper argues that both firms matter in the integration decision. To explain how, I construct two property-rights models by introducing the two-directional integration setup in Grossman and Hart (1986) into Antras (2003) and Antras and Helpman (2004). One model features homogeneous firms; the other model features heterogeneous firms. In these models, a buyer firm and a seller firm choose one of three ownership structures: buyer integration of the seller, seller integration of the buyer, and outsourcing. Both firms’ idiosyncratic characteristics influence the choice of ownership structure. Predictions of the models are examined in a novel dataset of 209,062 buyer-seller relationships in 154 countries/territories. Both models receive strong and robust support. By allowing either firm to become the owner in an integrated relationship, this paper explains the coexistence of backward and forward integration, which occurs in 758 of the 2282 industry pairs that contain integrated relationships and is assumed away by the existing literature.