CONTRACTUAL INSTITUTIONS, FINANCIAL DEVELOPMENT ANDVERTICAL INTEGRATION: THEORY AND EVIDENCE

This paper presents an industry equilibrium model of vertical integration under contractualimperfections with speci…c input suppliers and external investors. I assume that vertical inte-gration economizes on the needs for contracts with speci…c input suppliers at the cost of higher…xed costs. I show that contractual frictions with external investors a¤ect vertical integrationthrough two opposing channels whose relative intensities depend on other determinants of …rmssize distribution in the industry. Using cross-country-industry data, I present novel evidence onthe institutional determinants of international di¤erences in vertical integration which is consis-tent with the predictions of the theoretical model. In particular, I show that countries with moredeveloped …nancial systems are relatively more vertically integrated in industries that employ ahigh share of workers in large fi…rms...