The Property Rights Theory of Vertical Integration at ISNIE/SIOE 2015

By Ricard Gil

A recurring topic of research at ISNIE in the past and at SIOE in the future has been empirical work on vertical integration. In that literature, most work has concentrated around transaction cost economics (TCE) but yet empirical evidence on property rights theories (PRT) is lacking.

Fortunately this year was a bit unusual in that ISNIE/SIOE had three papers (out of five total on vertical integration) testing and providing consistent evidence with PRT predictions. What is even more delightful is that each one of the three papers presents supporting evidence of PRT from a different perspective.

The first paper in that group (and winner of the Oliver Williamson Best Conference Paper Award) is “Innovation Activities and the Incentives for Vertical Acquisitions and Integration” by Laurent Fresard (University of Maryland), Gerard Hoberg (University of Southern California) and Gordon Phillips (University of Southern California). In this paper, the authors show that vertical acquisition and vertical integration are more likely to occur in industries with more patents but they are less likely to take place in industries that are less R&D intensive. These results are PRT consistent in that ownership seems to be allocated to that party whose incentives are more important to value generation.

The second paper (in the same session as the previous paper) is “Mergers and Acquisitions in the US Video Game Industry: Assessing Theories of Vertical Integration” and written by yours truly and Frederic Warzynski (Aarhus University). That paper shows that, consistently with PRT predictions, games developed by acquired video game developers after acquisitions perform worse (lower sales) than games developed by the same video game developers before being acquired by publishers. The neat part of this setting is that the econometrician is able to observe the developer after being acquired and becoming a unit inside the acquiring firm. The setting allows them to observe “Fisher Body after being acquired by GM” so to speak.

The last and third paper is “The Property Rights Theory of Vertical Relations: Evidence from the Hollywood Studio Era” by F. Andrew Hanssen (Clemson University) and Alexander Raskovich (U.S. Department of Justice). That paper follows a different approach from those above in that it leverages a plausible exogenous change in ownership when the studio system broke down. Actors (agent) played a higher diversity of roles during the studio era and specialized more after the studio system broke down. The authors relates this to studios making larger investments in actors to figure out what their actual best roles were than later on (similar argument to Woodruff, 2002 in his paper on Mexican footwear and PRT).

What is there to like about these three papers? Well, it does seem that PRT empirical tests are being set around innovative and creative industries, and that makes sense because of the non-contractibility nature of the effort in that framework. But also, research is getting more and more creative in finding ways to provide evidence consistent with those theories that are lacking on the empirical front. What will we see in SIOE 2016? More papers on PRT? More papers on vertical integration as part of an incentive system? Or will we see more examples of vertical integration to facilitate adaptation? I guess we will have to wait and see until Paris in June of 2016!