DP4186 | Do Vertical Mergers Facilitate Upstream Collusion?

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In this Paper we investigate the impact of vertical mergers on upstream firms? ability to sustain collusion. We show in a number of models that the net effect of vertical integration is to facilitate collusion. Several effects arise. When upstream offers are secret, vertical mergers facilitate collusion through the operation of an outlets effect: cheating unintegrated firms can no longer profitably sell to the downstream affiliates of their integrated rivals. Vertical integration also facilitates collusion through a reaction effect: the vertically-integrated firm?s contract with its downstream affiliate can be more flexible and thus allows a swifter reaction in punishing defectors. Offsetting these two effects is a possible punishment effect that arises if the integrated structure is able to make more profits in the punishment phase than a disintegrated structure.