Essays on Corporate Vertical Integration

My Dissertation examines the corporate diversification strategy of vertical integration. Vertical integration refers to the organizational structure in which divisions within the firm are integrated along the supply chain. I examine the advantages and disadvantages associated with vertical integration in two chapters. In Chapter 2, I model how inter-divisional spillover effects mitigate internal capital market (ICM) inefficiencies. The model shows that the spillover effect helps align the objectives of division managers and the objective of the CEO and the firm, and thus facilitates efficient capital allocation at equilibrium. Empirically, I measure the size of the spillover effect by the degree of vertical integration of the firm. I present evidence that higher level of vertical integration is associated with more efficient internal capital markets. In Chapter 3, I show that vertically integrated firms are relatively lower valued firms. Using a vertical integration coefficient (VIC), constructed with Industry Benchmark Input-Output accounts data, provided by the Bureau of Economic Analysis (BEA), I find that compared to laterally integrated firms, vertical integration is associated with a significant firm value discount of approximately 1.56%. Even more strikingly, compared to firms located in the lowest VIC quartile, firms located in the highest VIC quartile exhibit a significant larger discount of approximately 3.34%. I find that there are two important sources of this additional discount: lower profit margins and more cross-subsidization