Ownership and Performance in Vertical Relations: Satellite-tracked Evidence∗

Using satellite-tracked real-time data on the movements of a vertically integrated fishing firm’s own ships and its long-term supplier ships, this paper studies the impact of integration after the acquisition of those suppliers. The results suggest an increase in obedience to deployment policies, no change in fishing skills, higher productivity, and higher downstream product quality brought about by integration. Evidence consistent with ownership-based authority, and inconsistent with other mechanisms, is provided. ∗I am indebted to the Firm, whose identity is suppressed for confidentiality, for access to its data and for numerous conversations with shareholders, managers, and workers. I also thank the Ministry of Production of Peru for access to data. John Asker encouraged me to write this paper, and his insight is much appreciated. Thanks are also due to Adam Brandenburger, Ricard Gil, Nan Jia, Jeffrey Macher, Gonçalo Pacheco-de-Almeida, Rob Seamans, Olav Sorenson, Catherine Thomas, Maggie Zhou, participants at the Econ-of-Strategy conference in New York, the ISNIE conference at Stanford, the AOM PDW on Firm Scope in San Antonio, and seminars at the University of Maryland, the University of Piura, and the Peruvian Central Bank. No confidential information is disclosed here. †Contact: Gabriel Natividad, NYU Stern. 40 West Fourth St., Tisch Hall 723, New York, NY 10012. Phone: (212) 998-0108. Fax: (212) 995-4235. E-mail: [email protected] The authority brought about by ownership enacts the right to give orders and control the operations and profitability of the firm (Grossman and Hart 1986, Hart and Moore 1990, Bolton and Dewatripont 2011). Authority is typically exercised within an organization rather than over the market, thus becoming one of the key constructs in theories of vertical integration (Gibbons 2005). Because the acquisition of control may broadly affect the way assets are allocated and output is transferred (Williamson 1975), while at the same time it may be motivated by the non-contractible nature of vertical relations (Hart and Moore 1990), arguments about authority vary substantially and sometimes conflict in the literature (Whinston 2001). Generally, it is well understood that the authority enacted by ownership has significant performance implications in vertical relations, at least in theory. Despite the growing interest in understanding the value consequences of vertical integration, empirical evidence on the specific impact of increased authority in vertical relations is very limited.1 Recent work has discovered important performance implications of vertical integration in incomplete contracting environments (Novak and Stern 2008, Lederman and Forbes 2010), but the potential benefits and costs enacted by the increased authority brought about by integration have not yet been explored. This paper provides direct evidence on the consequences of vertical integration on costly obedience and productivity consistent with the existence of an authority mechanism that may have lain hidden in the broader study of vertical scope and organizational form. To explore the authority channel in vertical integration, this paper introduces a unique proprietary database with the satellite-tracked real-time operations of a large vertically integrated fishing firm (hereafter the Firm2) in running its own ships and its relationships with long-term contractual suppliers providing it with fish for processing between 2003 and 2010. (Vertical integration is defined as a firm’s capability to transform fish on land). Because a great deal of decisions are made on the spot, when a ship is on the ocean and managers are on land, the satellite-tracked movements of ships allow us to observe the impact of vertical integration on asset operations with precision. Moreover, because the asset operators’ incentives and the market value of ship catches are observable, the authority mechanism linking authority, obedience, and performance under vertical integration can be explored. The difficulty in analyzing the performance implications of vertical integration must be stressed from the outset. Ideally, to estimate the causal effects of integration on performance, an identical Recent papers have studied interpersonal authority in organizations without emphasizing changes in ownership (Liberti 2005, Wu 2011). Other research has focused on changes in ownership that ensure financial control of investments, without examining authority in vertical relations (Pérez-González 2005). The Firm ranked among the five largest fishing companies in the world at some point during the period studied; this ranking changes frequently so it is not easy to identify any given firm. In keeping with our confidentiality agreement, the Firm’s name is omitted.