The Role of Transaction Costs on Vertical Integration and Innovation: A General Equilibrium Approach

Abstract

Acquiring information from outside firms is crucial for a firms’ innovation output. According to the transaction cost perspective, firms can increase the information flow between them by integrating. This view, however, usually considers only pairs of firms. This paper applies a general equilibrium approach to transaction costs to assess how vertical integration impacts a dyad’s ability to get information from other firms in the market. The model shows that, in general, we need to understand the transaction costs between all agents in the economy. Additionally, this paper breaks down the innovation process into three stages (information sharing, R&D investment, and innovation adoption) and shows the situations in which the inability to write contracts in each stage will impede an innovation to arrive in the market.