Contract Enforcement and Vertical Integration: Evidence from China's Manufacturing Firms

Abstract

It has been taken for granted in the literature on the determinants of vertical integration that the effectiveness of contract enforcement is guaranteed, which is far from true even in some developed countries. In this paper, using a World Bank data set of manufacturing firms in China, we investigate how the variations in the effectiveness of contract enforcement across China's cities affect the degree of vertical integration. We find that weaker contract enforcement causes firms to be more vertically integrated, and that firms with greater reliance on external environment are more vertically integrated in cities with poorer contract enforcement.

Keywords: Contract Enforcement, Vertical Integration, Legal Origin, Transaction Cost Economics

JEL Classification: L23, D23, P26, K12