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Vertical Foreclosure and Specific Investments

Author

Listed:
  • Rachel E. Kranton

    (Department of Economics, University of Maryland)

  • Deborah F. Minehart
Abstract
Are vertical mergers efficient or restraints to trade? This paper examines this long-standing question in a new setting and reaches new conclusions. We consider a realistic environment where downstream firms can make specific investments in several suppliers at once. In keeping with the "Chicago School" of regulation, we assume inputs are exchanged efficiently regardless of the ownership structure. Nevertheless, we find that vertical merger can be inefficient. A merged firm has an incentive to manipulate its ex ante investments to increase the ex post revenues of its supply unit. It will increase its investment in its internal supplier and decrease its investment in an external supplier relative to the efficient level of investments. The "skewing" is reinforced in equilibrium by other buyers who respond by skewing their own investments. The result is a reduction in the variety of inputs purchased by downstream firms. We relate the theory to studies of vertical mergers in pharmaceuticals and cable television.

Suggested Citation

  • Rachel E. Kranton & Deborah F. Minehart, 2002. "Vertical Foreclosure and Specific Investments," Economics Working Papers 0013, Institute for Advanced Study, School of Social Science.
    • Handle: RePEc:ads:wpaper:0013
    as

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    References listed on IDEAS

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    Cited by:

    1. Ursino Giovanni, 2015. "Supply Chain Control: A Theory of Vertical Integration," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 15(4), pages 1831-1866, October.
    2. Nepelski, Daniel, 2009. "Value chain structure and �exible production technologies," MPRA Paper 26236, University Library of Munich, Germany.
    3. Vladimir Dvoracek, 2009. "Vertical Integration and Sunk Capital in Transition Economies," Oxford Development Studies, Taylor & Francis Journals, vol. 37(1), pages 19-32.

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    More about this item

    JEL classification:

    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

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