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Does Contract Complexity Limit Opportunities? Vertical Organization and Flexibility

Abstract

The vertical organization of production entails a range of make-or-buy decisions of intermediate goods that are influenced by the difficulty of writing contracts with a potential supplier. When contracting causes high transaction costs, a firm can decide to vertically integrate the production of the intermediate product. Contract complexity can be measured by decomposing the range of inputs into inputs that are traded on an exchange (low contract complexity), inputs for which reference prices exist (low to medium contract complexity) and other, often relationship-specific inputs (medium to high contract complexity). This inaugural lecture addresses the impact of contract complexity on the growth opportunities of a firm. The present value of growth opportunities are embedded in the market value of a firm, which is a multiple of the firm’ stock price. Examining the relation between the growth opportunities as part of the market value and contract complexity, we find that contract complexity has a negative impact on

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