Contract Incompleteness, Globalization and Vertical Structure:an Empirical Analysis

This paper studies the e¤ects of international openness and contracting institutions on verticalintegration. It …rst derives a number of predictions regarding the interactions between trade bar-riers, contracting costs, technology intensity, and the extent of vertical integration from a simplemodel with incomplete contracts. Then it investigates these predictions using a new dataset ofover 14000 …rms from 45 developing countries. Consistent with theory, the e¤ect of technology in-tensity of domestic producers on their likelihood to vertically integrate is decreasing in the qualityof domestic contracting institutions and in international openness. Contract enforcing costs areparticularly high in developing countries and their e¤ects on the vertical structure of technologicalintensive …rms may have signi…cant welfare costs. If improving domestic contracting institutionsis not feasible an equivalent solution is to increase openness to international trade. This woulddiscipline domestic suppliers reducing the need for vertical integration....