Vertical Integration for Quality Signaling

Abstract

In the presence of consumers incomplete information of firms

ability to produce quality components, we analyze firms incentive

to commit to a long-term relationship as a way to convince consumers

about forming a high-type pair. In contrast to the result

of no brand leverage obtained by Choi and Jeon (2007), our analysis

demonstrates that a brand-named firm can restore its leverage

by committing to a long-term relationship. To overcome the time

inconsistency problem in a long-term contract, firms may utilize

vertical integration with relation-specific investment. This signaling

motivation for vertical integration is different from the explanations

that currently exist.