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The Choice of Organizational Form: Vertical Financial Ownership versus Other Methods of Vertical Integration (Joe Mahoney, SMJ 1992). I-Chen Wang. Vertical Integration. Mkt. Intermediate forms of VC. VFO. Distinction between Concepts. Vertical Financial Ownership (VFO henceforth)

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The Choice of Organizational Form: Vertical Financial Ownership versus Other Methods of Vertical Integration (Joe Mahoney, SMJ 1992)

I-Chen Wang


Distinction between concepts

Vertical Integration Ownership versus Other Methods of Vertical Integration (Joe Mahoney, SMJ 1992)

Mkt.

Intermediate forms of VC

VFO

Distinction between Concepts

  • Vertical Financial Ownership (VFO henceforth)

    • Elimination of contractual or market exchanges + substitution of internal transfers within the boundaries of the firm

  • Vertical Contracting (VC henceforth)

    • A variety of contractual relationship, e.g. resale price maintenance, exclusive dealing, franchising, etc.


Vertical integration strategy
Vertical integration strategy Ownership versus Other Methods of Vertical Integration (Joe Mahoney, SMJ 1992)

In the absence of agency theory and transaction costs, vertical financial ownership and vertical contracting are equivalent governance structures for achieving corporate objectives.

Research question: When market mechanisms are sufficient, when intermediate forms of vertical contracting become necessary, and when vertical financial ownership becomes the preferred governance structure


To overcome market failures
To Overcome Market Failures Ownership versus Other Methods of Vertical Integration (Joe Mahoney, SMJ 1992)

  • Market failures call for “institutions of capitalism”

  • Causes of market failures:

    • Opportunism

    • Environment uncertainty/complexity + bounded rationality

    • Asymmetric information

    • Small numbers bargaining situation + asset specificity


Vertical integration
Vertical integration Ownership versus Other Methods of Vertical Integration (Joe Mahoney, SMJ 1992)

  • Strategic considerations

    • Eliminate competition, e.g., oil refiner

  • Output and/or input price discrepancies

    • Eliminate monopoly power from each production stage, minimizing risk of appropriation

  • Uncertain costs and prices

    • Holding asset specificity constant, VI increase with uncertainty (TCE); but, increase in uncertainty leads to less specialized assets (Harrigan)

    • Output measurability, shirking


Advantages of vfo
ADVANTAGES OF VFO Ownership versus Other Methods of Vertical Integration (Joe Mahoney, SMJ 1992)

  • Transaction costs theory suggests the following:

    • Profit – eliminate preemptive claims on profits between separate firms

    • Coordination and Control – better control of opportunistic behavior due to authority relationships; disputes handled more effectively

    • Audit and Resource Allocation – ability to audit whole firm; ability to control all resources

    • Motivation – solidarity and clan-like emotions

    • Communication – improved coding system


The disadvantages of vfo
The Disadvantages of VFO Ownership versus Other Methods of Vertical Integration (Joe Mahoney, SMJ 1992)

  • Bureaucratic costs

    • Implementation costs

    • Loss of high-powered market incentives

    • High internal costs

  • Strategic costs

    • Loss of access to info. and tacit knowledge

    • Increasing sunk cost and/or chronic excess capacity

    • Over psychological commitment

  • Production costs

    • Cost disadvantages without minimum efficient scale

    • Capital drain

    • Capacity imbalance

      ----VFO is not sufficient to meet those considerations!


  • To integrate vfo vc and tcs
    To Integrate VFO, VC and TCs Ownership versus Other Methods of Vertical Integration (Joe Mahoney, SMJ 1992)

    • Dimensions of transaction costs

      • Frequency: occasional or recurrent transactions

      • Uncertainty: demand and technological

      • Asset specificity: human, physical and/or site firm-specific investments

    • Dimensions of agency costs

      • Non-separability problems: asymmetry info. b/w output and effort

      • Task programmability: knowledge of the transformation process


    Proposition
    Proposition Ownership versus Other Methods of Vertical Integration (Joe Mahoney, SMJ 1992)

    Non-separability, programmability (agency theory Information asymmetry), specificity (TCE) are three factors to suggest the vertical ownership decision


    Contributions and implications
    Contributions and Implications Ownership versus Other Methods of Vertical Integration (Joe Mahoney, SMJ 1992)

    • Theoretical contributions

      • Propose a general theory of vertical integration strategy

      • Fill in the research gap by incorporating the vertical governance structure comparison

      • Integrate the agency and transaction costs theory

    • Empirical implications

      • Empirical study on the three variables are warranted

      • Whether the dimensions of TCs specified here are “sufficient statistics” for predicting organization form

      • Whether the efficiency orientation alone is adequate to predict organization form


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