Abstract: We examine the incentives for firms to vertically integrate through acquisitions and production. We develop a new firm-specific measure of vertical relatedness and integration using 10-K product text. We find that firms in high R&D industries are less likely to become targets in vertical acquisitions or to vertically integrate. These findings are consistent with the idea that firms with unrealized innovation avoid integration to maintain incentives to invest in intangible assets and to keep residual rights of control as in Grossman and Hart (1986). In contrast, firms in high patenting industries with mature product markets are more likely to vertically integrate, consistent with control rights being obtained by firms to facilitate commercialization of already realized innovation.

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