Vertical Integration and Relational Contracts: Evidence from Costa Rica’s Coffee Chain

Abstract: When contracts are incomplete, contractual parties can substitute the market with either repeated transactions or with integration. This paper compares vertical integration and relational contracts between coffee mills and exporters in Costa Rica. Detailed data on transactions between and within firms reveal that integrated trade is shielded from demand uncertainty, a key force shaping market transactions. Relational contracts between firms display trading patterns qualitatively similar to those within integrated chains but do not achieve the same degree of market assurance. Integration, however, comes at the cost of worse market access and relationships with independent sup-pliers. The evidence strongly supports models in which firms boundaries alter temptations to renege on relational contracts and, through this channels, alter the allocation of resources. Policy implications for export-oriented agricultural chains in developing countries are discussed.