Vertical Integration and Firm Performance

Theoretical and empirical research in the past decades has advanced our understanding of what determines the vertical boundary of a firm. An equally important but much less understood issue is the impacts of vertical integration on firm performance, mainly because the decision on vertical integration is endogenously determined. In this paper, using a survey of China's manufacturing firms conducted by the World Bank, we establish the causal impacts of vertical integration on firm performance by adopting the instrumental variable approach to deal with the endogeneity issue. We find that the degree of vertical integration causes a negative impact on firm sales, market share and productivity, but a positive impact on firm product prices. Our results lend support to the extent of market argument in the literature, and they are consistent with the stated reasons for the divesture decisions of many business corporations