The Costs andBenefits ofOwnership:ATheory ofVertical andLateral IntegrationSanford J.Grossman
Massachusetts nstitute of Technology
Ourtheoryofcostlycontracts emphasizes that contractual rights canbeof two types: specificrights and residualrights. When it is costly tolist all specific rights overassets in the contract,it may be optimal toletone party purchase allresidual rights.Ownership is the purchaseofthese residual rights.When residual rightsare purchased by oneparty,they are lost by asecond party, andthis inevitably createsdistortions.Firm1purchases firm 2 when firml's control increasestheproductivity of itsmanagement more than the loss of controldecreases theproductivity of firm 2'smanagement.I.Introduction
Whatis a firm?What are thedeterminants ofhowverticallyorlater-allyintegratedtheactivitiesofthefirmare? Thispaperbuilds on thefoundations laidby Coase(1937), Klein,Crawford,andAlchian(1978), and Williamson(1979), whichemphasize the benefits of"con-
Research wassupported bytheNational ScienceFoundation,the AlfredP.SloanFoundation,and the International Centrefor Economicsand RelatedDisciplinesattheLondonSchoolofEconomics.Thisis anextensivelyrevisedversionof an earlierpaper(Grossmanand Hart1984).Wegratefully acknowledgehelpfulcomments fromDebraAron, PeterDiamond,RichardEpstein,NaavaGrossman,PaulJoskow, JohnMinahan,JimPoterba,AndrewPostlewaite,PeterThistle,MartinWeitzman,OliverWilliamson,CharlesWilson,ToniZabalza,and two referees.