Come Together: Firm Boundaries and Delegation

Abstract: Little is known about the relationship between firm boundaries and the allocation of decision rights within firms. We develop a model in which final good producers choose which suppliers to integrate and whether to delegate decisions to integrated suppliers, when there is uncertainty in the production process. In this setting, integration has an option value: ownership rights give firm owners authority to delegate or centralize production decisions, depending on who can best solve the realized problems. To assess the evidence, we construct measures of vertical integration and delegation for thousands of firms in many countries and industries. Consistent with the model, we find that firms are more likely to delegate to suppliers of more valuable inputs and are more likely to integrate suppliers that produce more valuable inputs. Moreover, input risk increases the probability that a firm integrates a supplier, but has no impact on delegation choices