Incomplete contracts, vertical integration and product market competition

This paper adopts an incomplete contracts approach to vertical integration, relating the choice of ownership structure explicitly to the investment incentives of self-interested agents. In particular, we focus on the dependence of equilibrium industry ownership structure on two key influences: the relative effectiveness of upstream (versus downstream) investment and the toughness of final product market competition. Concentrating asset ownership in downstream hands encourages specialisation in final good production, at the expense of valuable investment in input production. The attractions of foreclosure-inducing integration are found to decrease with the relative effectiveness of upstream investment, but vary non-monotonically with increases in the toughness of competition.