Relational Adaptation and the Costs and Benefits of Vertical Integration: Evidence from Costa Rica Coffee

Abstract: We exploit a detailed transaction level dataset of contracts between coffee mills and exporters in Costa Rica to provide evidence on how market and supply assurance considerations shape market structure as well as the costs and benefits of vertical integration. We begin by documenting a demand for market assurance: within relationships prices for coffee are i) inverted-U shaped during a harvest season and ii) lower for mills that have large amounts of unsold coffee at a given point in time. Vertical integration insulates from market forces: trade within vertically integrated structures does not features the two facts above and generally occurs with much shorter lead time. We then exploit unanticipated changes in world coffee prices to study how vertical integration affects contract renegotiation. When international coffee prices at the time of delivery largely exceed expectations at the time of contracting sellers have an incentive to renege on the contracts. Contracts between integrated buyers and non-integrated sellers are more likely to be renegotiated. The opposite is true for contracts between integrated sellers and non-integrated buyers. Additional evidence distinguishes between insurance considerations and endogenous costs of vertical integration in sustaining relational trade in the market.