A Theory of Firm Boundaries and Knowledge Sharing

Abstract

We develop a theory of how integration shapes knowledge sharing. Parties hold private information essential for coordination, but they can also expropriate each other’s knowledge. Asset ownership grants control over expropriation, creating a trade-off: the owner freely shares knowledge, while the non-owner partially withholds information to avoid expropriation. Thus, the asset is optimally allocated to the party with the lowest temptation to expropriate. Extending the model to multiple downstream and upstream parties, we show that the optimal industry configuration may involve a large firm acting as a knowledge intermediary, aggregating information across competing firms that are reluctant to share it directly. Finally, we identify conditions on knowledge characteristics and contracting environments under which integration becomes necessary for effective knowledge transfer, as optimal outcomes cannot be achieved through contracts alone.