A price theory of vertical and lateral integration under productivity heterogeneity

We analyze the interplay between product market prices and firm boundary decisions. Enterprises are heterogeneous with respect to productivity and they choose between two ownership structures—while centralized ownership (integration) performs well in coordinating managerial actions, dispersed ownership (non-integration) is conducive to poor coordination. Ownership structure is monotone, i.e., high-productivity enterprises integrate while the low-productivity ones stay separate. Price can be positively or negatively associated with integration, depending on how price changes affect the distribution of surplus within an enterprise. A negative association may result in a backward-bending industry supply. Our model delivers novel empirical and policy implications.