Markets, Contracts, and Hierarchies: How Do Bargaining Frictions Affect Governance?

Abstract

We develop an organizational governance model with a single buyer and endogenous upstream entry. Investments and control rights over assets and actions are immediately contractable; production is contractable after uncertainty resolves. We show the following: Supplier competition eliminates pre-entry bargaining frictions. To minimize post-entry bargaining frictions, control rights over assets and actions are always bundled. If entry is sufficiently cheap, there is frictionless post-entry competition, sometimes due to buyer sponsorship. Otherwise, only one supplier enters. There is vertical integration if the asset's expected profitability is highest in the buyer's favorite use; if not, the buyer contracts with an autonomous supplier.