Property Rights, Firm Boundaries, and R&D Inputs

Abstract

This Article offers an explanation of the role of intellectual property rights (IPRs) in information-intensive vertical supply relationships. In particular, we explore the connection between stronger property rights and the enhanced viability of independent (versus vertically integrated) input supply firms when contracts are incomplete. We start by modeling a tradeoff between two types of information transfer in buyer-supplier relationships: "synergies," in which joint efforts reveal new applications of existing technology; and "leakage," or disclosure of existing information. We show that property rights in the hands of an independent input supplier can create the potential for greater inter-firm synergy, outweighing the risk of leakage. Greater synergies arise due to the supplier's greater effort to adapt its generalized technology to the specific needs of the buyer. Property rights play a crucial role: they reduce the risk of buyer firm opportunism, in effect raising the cost of the buyer's "outside option" in the event the supplier-buyer contract is terminated. The "residual" nature of property rights as described for example by Hart (1995) makes them more effective in this regard than contracts alone. We extend our basic results to analysis of buyouts and spinoffs, and assay an extensive body of empirical evidence. Broad support is found for our approach, pointing the way to future exploration of the relationship between property rights specifications and the opening up of new contracting horizons.

JEL Classification: K11, K19, L22