Technical efficiency and the vertical boundaries of the firm: theory and evidence

Abstract

This article provides a theoretical and empirical analysis of the relationship between firms’ technical efficiency and the vertical organization of production. Technical inefficiency is explicitly introduced as the source of firms’ heterogeneity in a Bertrand–Nash model of industry competition: the main prediction of the model is that the most efficient firms choose vertical integrated structures and the less-efficient ones choose disintegrated structures. The empirical part of the article rests on a stochastic frontier analysis (SFA) in a sample of about 400 Italian machine tool (MT) builders, and the result supports the prediction of the theoretical model.

Keywords:

• vertical integration
• technical efficiency
• firm heterogeneity
• stochastic frontier analysis

JEL Classification:

• D24
• L23
• L64

Acknowledgements

Fabio Pieri greatly acknowledges the financial support from the Spanish Ministry of Science and Innovation (project MINECO ECO2011-27619, co-financed with FEDER).

Notes

¹  Melitz and Ottaviano (2008). 

²  For example, the production of mechanical components or electronic assemblies.