The effect of firm count on the extent of vertical integration: An empirical investigation of the inorganic chemical industry

This research tests Oliver Williamson's contention that supplier firm count affects a plant's extent of vertical integration. The alternative is Stigler's hypothesis that the extent of downstream demand determines the extent of integration, with the largest plants specializing production in the upstream market. Williamson counters that fear of opportunism due to a small firm count determines the extent of integration. The lack of a consistent vertical integration measure and detailed aggregated data limited efforts to measure the effect of firm count.; A consistent quantity based measure of vertical integration was constructed using disaggregated homogeneous product data from the inorganic chemical industry collected by the Census Bureau. This measure is a ratio of quantity consumed divided by total plant output (outside shipments plus internal consumption). To control for other causes of vertical integration, several fixed-effects models are tested using a variety of variables that measure for plant rents subject to opportunism, product economies of scope, and economies of scale. Several non-linear models test for differences in behavior by the largest and smallest plants.; Results indicate firm count has a negative effect on the extent of vertical integration, after controlling for other causes for vertical integration. These results were consistently significant. The results of the size dummies did support Stigler's hypothesis that the largest producers tend to specialize. However, the results were consistent across all products studied in that the smallest plants specialized.; Low firm count for a particular product forces a firm to hedge against the threat of opportunism. Given that the results imply that only the smallest plants and producers tended to specialize, this supports a theory that small fringe producers supply large integrated plants during times of high downstream demand.