DP3565 Vertical Integration and Distance to Frontier

Author(s): Daron Acemoglu, Philippe Aghion, Fabrizio Zilibotti
Publication Date: October 2002
Keyword(s): contracts, economic growth, internal organization of the firm, vertical integration
JEL(s): L16, L22, O31, O33, O38, O40
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3565

We construct a model where the equilibrium organization of firms changes as an economy approaches the world technology frontier. In vertically integrated firms, owners (managers) have to spend time both on production and innovation activities, and this creates managerial overload, and discourages innovation. Outsourcing of some production activities mitigates the managerial overload, but creates a holdup problem, causing some of the rents of the owners to be dissipated to the supplier. Far from the technology frontier, imitation activities are more important, and vertical integration is preferred. Closer to the frontier, the value of innovation increases, encouraging outsourcing.