Abstract: We jointly study firm boundaries and the allocation of decision rights within them by confronting an incomplete-contracts model with data on vertical integration and delegation for thousands of firms around the world. Integration has an option value: it confers authority to delegate or centralize decision rights, depending on who can best solve problems that arise in the course of an uncertain production process. In line with the model’s predictions, we find that firms are more likely to integrate suppliers that produce more valuable inputs and operate in industries with more dispersed productivity and that firms delegate more decisions to integrated suppliers that produce more valuable inputs and operate in more productive industries.
JEL classiﬁcation: D2, L2.
Keywords: Integration, delegation, uncertainty, real options, supply assurance.