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We study the relationship between exporters' organizational structure and output quality. If only input quantity is observable, theory predicts that vertical integration may be necessary to incentivize suppliers to increase input quality. Using data on suppliers' behavior, supplier ownership, supply transactions, and manufacturers' output by quality grade and exports from the Peruvian fishmeal industry, we show the following. After integrating with the plant being supplied and losing access to alternative pay-per-kilo buyers, suppliers take more quality-increasing and less quantity-increasing actions. Integration consequently causally increases output quality, and manufacturers integrate suppliers when facing high relative demand for high quality grades.

Zonder onderwerpscode: economie

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• Reference Manager
• EndNote
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We study the relationship between firms' output quality and their choice of organizational structure. To do so, we use data on each step of the production and transaction chain that makes up Peruvian fishmeal manufacturing. We first show that quality upgrading is an important motive for vertically integrating. Firms integrate suppliers when the quality premium--the relative price of high quality output--rises for exogenous reasons, but not when average or low quality prices rise. The greater a firm's scope for shifting low to high quality production, the greater its integration response. We then show that integration changes suppliers' production behavior. A given supplier's actions are less geared towards increasing quantity and more geared towards maintaining input quality after the supplier is integrated and loses access to alternative pay-per-kilo buyers. Finally, we show that firms and individual plants that use integrated suppliers at the time of production ultimately produce a significantly higher share of high quality output. In sum, our results suggest that firms change their organizational structure when their output quality objectives change because controlling the incentives of independent suppliers facing a quantity-quality trade-off is difficult, as classical theories of the firm predict.