What Does Governance Do? Evidence From Airlines

Abstract

Extant research on firm boundaries provides limited insight on the mechanisms through which vertical integration improves supplier performance, and on the extent to which contracts can substitute for it. Using rich data from the US airline industry, we shed new light on both questions. First, we show that flights ticketed by a major airline are less delayed if operated by the major’s employees than by the employees of an outsourced regional partner, holding the major’s control over alienable decisions constant. This evidence provides rare support for the view of the firm as a mechanism to monitor and incentivize employees (Holmstrom and Milgrom, 1991; Holmstrom, 1999). Second, we compare vertical integration to relational and arm’s length outsourcing, and find that both vertically integrated flights and flights outsourced to relational partners experience similar delay reductions compared to flights outsourced to arm’s length partners. This results suggests that comparing vertical integration to an indistinct bundle of outsourcing relationships may overstate its effect.