Abstract
In this paper we propose an indirect test of the new institutional economics (Williamson, 1975, 1981, 1985) by exploring the relationship between vertical integration and uncertainty. We present evidence that suggests that vertical integration, executed by merger, may reduce a firm's systematic or undiversifiable risk. That is, vertical mergers reduce risk by more than the simple portfolio effects that arise from combining business units in which returns are not perfectly correlated, suggesting that internal organization does have distinctive properties which cannot be easily replicated by stockholders taking separate asset positions in specialized companies operating at each stage of an industry. Uncertainty creates several kinds of problems for the organization of production. One is that it complicates decisionmaking. Because of uncertainty and bounded rationality, comprehensive contingent planning on how to
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