DP12923 Come Together: Firm Boundaries and Delegation

Author(s): Laura Alfaro, Nicholas Bloom, Paola Conconi, Harald Fadinger, Patrick Legros, Andrew Newman, Raffaella Sadun, John Van Reenen
Publication Date: May 2018
Date Revised: February 2021
Keyword(s): Decentralization, real options, supply assurance, vertical integration
JEL(s): D2, L2
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12923

We jointly study firm boundaries and the allocation of decision rights within them by confronting an incomplete-contracts model with data on vertical integration and delegation for thousands of firms around the world. Integration has an option value: it confers authority to delegate or centralize decision rights, depending on who can best solve problems that arise in the course of an uncertain production process. The model can explain why more vertically integrated firms tend to delegate more, as observed in our data. In line with the model's predictions, we find that firms are more likely to integrate suppliers that produce more valuable inputs and operate in industries with more dispersed productivity, and that firms delegate more decisions to integrated suppliers that produce more valuable inputs and operate in more productive industries.