Come Together: Firm Boundaries and Delegation

Abstract

We develop an incomplete-contracts model to jointly study firm boundaries and the allocation of decision rights within them. Integration has an option value: it gives firm owners authority to delegate or centralize decision rights, depending on who can best solve problems that may arise in the course of an uncertain production process. To examine the evidence, we construct measures of vertical integration and delegation for thousands of firms in different countries and industries. In line with the model’s predictions, we find that input value and supplier uncertainty play a key role in shaping both integration and delegation choices.