Vertical Integration and Investor Protection in Developing Countries

The industrial organization of developing countries is characterized by the pervasive use of subcontracting arrangements among small, financially constrained firms. This paper asks whether vertical integration relaxes those financial constraints. It shows that vertical integration trades off the benefits of joint liability against the costs of rendering the supply chain more opaque to external investors. In contrast to the commonly held view that pervasive input and capital market imperfections are conducive to vertical integration, the model predicts that the motives for vertical integration are not necessarily higher in developing countries. In particular, vertical integration is more likely to arise at intermediate levels of investor protection and better contract enforcement with suppliers reduces vertical integration only if financial markets are sufficiently developed. Evidence supporting both predictions is discussed.Vertical Integration, Industrial Development, Financial Constraints, Joint Liability, Trade Credit, Community-based Industries

The value of relationships : evidence from a supply shock to Kenyan rose exports

This paper provides evidence on the importance of reputation, intended as beliefs buyers hold about seller's reliability, in the context of the Kenyan rose export sector. A model of reputation and relational contracting is developed and tested. We show that 1) the value of the relationship increases with the age of the relationship; 2) during an exogenous negative supply shock sellers prioritize relationships consistently with the predictions of the model; and 3) reliability at the time of the shock positively correlates with future survival and relationship value. Models exclusively focussing on enforcement or insurance considerations cannot account for the evidence

Financing experimentation

Entrepreneurs must experiment to learn how good they are at a new activity. What happens when the experimentation is financed by a lender? Under common scenarios, i.e., when there is the opportunity to learn by "starting small" or when "noncompete" clauses cannot be enforced ex post, we show that financing experimentation can become harder precisely when it is more profitable, i.e., for lower values of the known arm and for more optimistic priors. Endogenous collateral requirements (like those frequently observed in micro-credit schemes) are shown to be part of the optimal contract

Financing experimentation

Entrepreneurs must experiment to learn how good they are at a new activity. What happens when the experimentation is financed by a lender? Under common scenarios, i.e., when there is the opportunity to learn by "starting small" or when "no-compete" clauses cannot be enforced ex-post, we show that financing experi- mentation can become harder precisely when it is more profitable, i.e., for lower values of the known-arm and for more optimistic priors. Endogenous collateral requirements (like those frequently observed in micro-credit schemes) are shown to be part of the optimal contract

Loyalty, exit, and enforcement: evidence from a Kenya Dairy Cooperative

Organizations depend on members' "loyalty" for their success. Studying a cooperative's attempt to increase deliveries by members, we show that the threat of sanctions leads to highly heterogeneous response among members. Despite the cooperative not actually enforcing the threatened sanctions, positive effects for some members persist for several months. Other members "exit," stopping delivering altogether. Among non-compliant members we document substantial heterogeneity in beliefs about the legitimacy of the sanctions. This lack of common understanding highlights the role played by managers in organizations and provides a candidate explanation for lack of sanctions enforcement documented by Ostrom (1990) and other studies

Acquisitions, management and efficiency in Rwanda's coffee industry

Well-functioning markets allocate assets to owners that improve firms' management and performance. We study the effects of ownership changes on coffee mills in Rwanda - an industry in which managing relationships with farmers and seasonal workers is important and that has seen many ownership changes in recent years. We combine administrative data, a survey panel of mills and an original survey of acquirers that allows us to construct acquirer-specific and target-specific control groups. A difference-in-differences design reveals that ownership changes do not improve performance unless the mill is acquired by a foreign firm. Our preferred interpretation - supported by detailed survey evidence that considers alternative hypotheses - is that foreign firms successfully implement management changes in key operational areas. Upon acquisition, both domestic and foreign owned mills attempt to implement similar changes, but domestic firms face resistance from workers and farmers. Domestic owners have relationships with their local communities, which can create opportunities to establish new mills and acquire existing ones. However, these same relationships create pressure to maintain status-quo relational arrangements, which makes it harder to implement managerial changes

The value of relationships: evidence from a supply shock to Kenyan rose exports

This paper provides evidence on the importance of reputation in the context of the Kenyan rose export sector. A model of reputation and relational contracting is developed and tested. A seller's reputation is defined by buyer's beliefs about seller's reliability. We show that (i) due to lack of enforcement, the volume of trade is constrained by the value of the relationship; (ii) the value of the relationship increases with the age of the relationship; and (iii) during an exogenous negative supply shock deliveries are an inverted-U shaped function of relationship's age. Models exclusively focusing on enforcement or insurance considerations cannot account for the evidence

Financial constraints, industry structure and firm's boundaries

The first part of this Thesis analyzes the impact of financial constraints (FC) on industrial structure. Chapter 1 presents a model that disentangles several effects of FC on entry, turnover, productivity and firms size distribution. The framework is applied in Chapter 2 which develops an industry equilibrium model of vertical integration under contractual imperfections with specific input suppliers and external investors. I assume that vertical integration economizes on the needs for contracts with specific input suppliers at the cost of higher financial requirements. I show that the two forms of contractual imperfections have different effects on the degree of vertical integration, and that contractual frictions with external investors affect vertical integration through two opposing channels: a direct negative, investment, effect and an indirect positive, entry, effect. Using cross-country- industry data, I present novel evidence on the institutional determinants of international differences in vertical integration which is consistent with the predictions of the theoretical model. In particular, I show' that countries with more developed financial systems are relatively more vertically integrated in industries that are dominated by large firms. The second part (Chapter 3) asks whether vertical integration reduces or increases transaction costs with external investors. I build a model in which a seller produces a good that can be used by a buyer, or sold on a spot market. The buyer and the seller have no cash, need to finance investments for production, and can not foresee in advance whether the input is most efficiently traded on the spot market or among each other. I assume that ownership of physical assets gives control over contracting rights to those assets, that financial streams get transferred with ownership and that returns can not be perfectly verified. The net balance of the costs and benefits of integration in terms of pledgeable income depends on the relative intensities of a positive "profits-pooling" effect against a negative "de-monitoring" effect. I find that larger projects, more specific assets, and low' investors protection are determinants of vertical integration. I discuss joint liability contracts between non integrated firms and how contractual externalities among investors favor integration

Market size, markups and international price dispersion in the cement industry

Prices for several intermediate inputs, including cement, are higher in developing economies - particularly in Africa. Combining data from the International Comparison Program with a global directory of cement plants we estimate an industry equilibrium model to distinguish between drivers of international price dispersion: demand, costs, conduct, and entry. Developing economies feature both higher marginal costs and higher markups. African markets are not characterized by higher barriers to entry and, if anything, feature relatively more competitive conduct. The small size of many national markets, however, limits entry and competition and explains most of the higher markups. Policy implications are discussed

The market for training services: a demand experiment with Bangladeshi garment factories

We marketed a training program for lower level managers (line supervisors) to large factories in the Bangladeshi ready-made garment industry. Take-up of the program (even for a free slot) was low, due to intense production pressures, fire-fighting and concerns over retention of trained workers. Take-up is quite insensitive to pricing. There was higher interest and demand in training modules aimed at improving production processes and quality, rather than human resources and social compliance. Since the program was priced close to a commercially viable rate, it might be possible to develop a market provided they could be proved to be effective