Vertical integration is often proposed as a way to resolve hold-up problems. This ignores the empirical fact that division managers tend to maximize divisional (not firmwide) profit when investing. I develop a model with asymmetric information at the bargaining stage and investment returns taking the form of cash and gempire benefits.h Owners of a vertically integrated firm will then provide division managers with low-powered incentives to induce them to bargain more cooperatively, resulting in higher investments and overall profit as compared with nonintegration. Vertical integration therefore mitigates hold-up problems even without profit sharing. Ordering information: This article can be ordered from http://gemini.econ.umd.edu/cgi-bin/rje_online.cgi?action=buy&year=2006&issue=sum&page=276&tid=30492&sc=1869P1N9.
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