@techreport{Levy2003Boundary,
abstract = {In this paper I present a theory of the boundary of the firm that accounts for
some important characteristics of real-world multidivisional firms: Operative decisions
are in the hands of middle managers who are rewarded with incentive contracts based on
the performance of their units; Managers' decisions are subject to approval and
intervention by the top management of the firm; and managers are better informed
regarding the affairs of their divisions than their superiors in the firm's hierarchy. In this
setup, the integration of a producer of an intermediate input and its buyer as separate
divisions within a single firm is unambiguously desirable, as long as the choice of trading
partners can be credibly delegated to the divisions' managers. I show that this is satisfied
not only under the assumption of full commitment by the general office of the firm, but
also interestingly, if it has no commitment power at all. At the time of trade, the
uninformed general office prefers to delegate the choice of trading partners to the
divisions whose decision is ex-post optimal. An explanation of the boundaries of the firm
emerges only if we assume that the general office retains some limited commitment
power. The general office may then mandate internal trade in order to encourage the
divisions to specialize towards one another before the trade. In the context examined, I
show that the general office faces a 'time-consistency' problem. It tends to mandate
internal trades in more instances than would have been optimal with full commitment,
adversely affecting the levels of investment taken by the divisions' managers. Whenever
such inconsistency arises, it may be optimal to have the trade conducted between
independent, non-integrated parties.},
author = {Nadav Levy},
copyright = {http://www.econstor.eu/dspace/Nutzungsbedingungen},
keywords = {D23; L22; 330; Theorie der Unternehmung; F\"{u}hrungskr\"{a}fte; Hierarchie; Leistungsanreiz; Vertrag; Anreizvertrag; Transferpreis},
language = {eng},
number = {0035},
title = {The Boundary of the Firm in a Model of Trade Within a Hierarchy},
type = {CSIO working paper / Northwestern University, Center for the Study of Industrial Organization},
url = {http://hdl.handle.net/10419/23464},
year = {2003}
}
