An Examination of the Efficiency, Foreclosure, and Collusion Rationales for Vertical Takeovers

Abstract

We investigate the efficiency, foreclosure, and collusion rationales for vertical integration in a large sample of vertically related takeovers. The efficiency rationale, as discussed under the transaction cost economics and property rights theories, posits that vertical integration mitigates contractual inefficiencies between suppliers and customers (termed as holdup) and provides incentives to undertake relationship-specific investments. In contrast, the foreclosure and collusion rationales suggest that vertical integration is anticompetitive in nature. Specifically, the foreclosure argument suggests that vertical integration is used to raise costs of rival firms, and the collusion argument suggests that vertical integration facilitates coordination between the integrated firm and its rivals. To distinguish between the three hypotheses, we examine (1) the announcement period wealth effects to the merging firms, rival firms, and customer firms; and (2) the operating performance changes to the merging firms in vertical takeovers. We find that firms expand their vertical boundaries consistent with an efficiency enhancing rationale. This paper was accepted by Brad Barber, finance.

Airline Alliances, Antitrust Immunity, and Market Foreclosure

“…More recently, Hortacsu and Syverson (2007) found no evidence of anti-competitive effects of vertical foreclosure in the cement and ready-mixed concrete industries; instead, the authors suggest that vertical integration yields lower prices, higher quantity, and does not create any additional entry barriers. Shenoy (2008), using an event study analysis covering a large sample of mergers, claims that efficiency is the main rationale for mergers. Derdenger (2009) studies foreclosure in the video game console industry, and suggests it is pro-competitive.…”

Vertical Firm Boundaries: Supplier-Customer Contracts and Vertical Integration

“…The decision to vertically integrate is well researched in both the finance and economics literature. Recent theoretical research (e.g., Whinston, 2003) and empirical studies (Acemoglu, Johnson, and Mitton, 2009;Shenoy, 2012) examine the vertical integration decision as a solution to a number 30 I also estimate similar specifications using OLS and IV methods. These are omitted for brevity but are available upon request from the author.…”

“…Many studies (Fee, Hadlock, and Thomas, 2006;Kale and Shahrur, 2007;Shenoy, 2012, among many others) use R&D intensity to proxy for RSI. However, Acemoglu, Johnson, and Mitton (2009) instead use a measure of asset tangibility as their measure of RSI predicting vertical integration.…”

“…If regulators oppose integration between highly concentrated industries for foreclosure or collusion reasons (see Shenoy (2012) for a discussion of this literature), both Supplier Herfindahl…”

“…My study builds on the previous literature which has examined other solutions to transaction costs such as vertical integration (Chipty, 2001;Fan and Goyal, 2006;Acemoglu, Johnson, and Mitton, 2009;Shenoy, 2012) and partial equity stakes, strategic alliances, and joint ventures (Allen and Phillips, 2000;Fee, Hadlock, and Thomas, 2006). My results are also consistent with the notion that stock prices appear to contain product market-related information and, as such, support the conjecture 7 Acemoglu, Johnson, and Mitton (2009) do find evidence that contracting costs affect vertical integration.…”