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Vertical Integration and the Distribution of Property Rights

In: Economic Policy in Theory and Practice

Author

Listed:
  • Sanford J. Grossman
  • Oliver Hart

Abstract

What is a firm? What are the determinants of how vertically integrated are the activities of the firm? This paper builds on the foundations laid by Coase (1937), Williamson (1979) and Klein et al. (1978) which emphasise the benefits of ‘control’ in response to situations where there are difficulties in writing or enforcing complete contracts.1 We define the firm as being composed of the assets (e.g. machines, inventories) which it owns. We present a theory of costly contracts which emphasises that contractual rights can be of two types: specific rights and residual rights. When it is too costly for one party to specify a long list of the particular rights it desires over another party’s assets, it may be optimal to purchase all the rights except those specifically mentioned in the contract. Ownership is the purchase of these residual rights of control. We show that there can be harmful effects associated with the wrong allocation of residual rights. In particular a firm which purchases its supplier, thereby removing residual rights of control from the manager of the supplying company, can distort the manager’s incentives sufficiently to make common ownership harmful. We develop a theory of integration based upon the attempt of parties in writing a contract to allocate efficiently the residual rights of control between themselves.

Suggested Citation

  • Sanford J. Grossman & Oliver Hart, 1987. "Vertical Integration and the Distribution of Property Rights," Palgrave Macmillan Books, in: Assaf Razin & Efraim Sadka (ed.), Economic Policy in Theory and Practice, chapter 14, pages 504-548, Palgrave Macmillan.
    • Handle: RePEc:pal:palchp:978-1-349-18584-9_14
    DOI: 10.1007/978-1-349-18584-9_14
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    Citations

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    Cited by:

    1. Les Oxley & Paul Walker & David Thorns & Hong Wang, 2008. "The knowledge economy/society: the latest example of “Measurement without theory”?," The Journal of Philosophical Economics, Bucharest Academy of Economic Studies, The Journal of Philosophical Economics, vol. 2(1), pages 20-54, November.
    2. Thomas F. Hellmann & Veikko Thiele, 2012. "A Theory of the Firm based on Partner Displacement," NBER Working Papers 18495, National Bureau of Economic Research, Inc.
    3. Todorova, Tamara, 2010. "Vertical Integration in High-Transaction Cost Sectors: The Case of the Bulgarian Pharmaceutical Industry," EconStor Open Access Articles and Book Chapters, ZBW - Leibniz Information Centre for Economics, vol. 1(2 (Winter), pages 127-138.
    4. Valeria Gattai & Piergiovanna Natale, 2017. "A New Cinderella Story: Joint Ventures And The Property Rights Theory Of The Firm," Journal of Economic Surveys, Wiley Blackwell, vol. 31(1), pages 281-302, February.
    5. Paul Walker, 2008. "The (non)Theory of the Knowledge Firm," Working Papers in Economics 08/07, University of Canterbury, Department of Economics and Finance.

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