Abstract
Numerous product quality scandals are caused by low-quality inputs. When input quality is not perfectly observed by downstream firms, upstream firms often have moral hazard problems. If vertical integration does not directly eliminate the moral hazard problems, does vertical integration still improve product quality? If so, under which conditions? We find that given the precision of monitoring technology used by downstream firms, when the level of public monitoring is very high or very low, downstream firms have no incentive to integrate upstream firms; when the level is intermediate, downstream firms have incentives to integrate and vertical integration increases product quality.
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We like to thank Birger Wernerfelt, the audiences of 15th Annual International Industrial Organization Conference (Boston, 2017), The XXXIV Jornadas de Economia Industrial (Barcelona, 2018), TEAM seminar (Paderborn, 2017), Micro Seminar (Beijing, 2018) for their useful suggestions and feedback. Author Sanxi Li thanks the National Natural Science Foundation of China (Grant No. 72192801) for financial support.
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Li, S., Li, X. & Qu, Z. Does vertical integration increase product quality?. Econ Theory Bull 11, 69–80 (2023). https://doi.org/10.1007/s40505-022-00240-4
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DOI: https://doi.org/10.1007/s40505-022-00240-4