DP3942 Foreclosure with Incomplete Information

Author(s): Lucy White
Publication Date: June 2003
Keyword(s): asymmetric information, foreclosure, vertical integration
JEL(s): D42, D82, L12, L42
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=3942
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We investigate the robustness of the new foreclosure doctrine and its associated welfare implications to the introduction of incomplete information. In particular, we let the upstream firm’s marginal cost be private information, unknown to the downstream firms. The previous literature has argued that vertical integration is harmful because it allows an upstream monopolist to limit output to monopoly levels, whereas a disintegrated structure will ‘over-sell’, producing more in equilibrium. By contrast, we find that with incomplete information, high-cost firms will often ‘under-sell’ in equilibrium; that is, supply less than their monopoly output. Low-cost firms continue to over-sell, so all types of firms have a reason to integrate downstream, but this is socially harmful only for low-cost types. For high-cost firms vertical integration can be Pareto-improving, resulting in higher output, profits and consumer surplus.