Information concealment in the theory of vertical integration

A model of vertical integration is proposed in which the motive for vertical integration lies in the concealment of information to other firms, rather than uncovering of a new information. Since a vertically integrated firm trades internally rather than making publicly observable market transactions, vertical integration offers an opportunity for the integrated firm to turn previously observable market data into private information. It will be shown that when the acquisition cost of input is uncertain, the ex ante profit of a downstream firm will increase if the ex post realized value is private information, thereby providing a theory of vertical integration based on strategic information concealment. Welfare implications of vertical integration are also considered. Finally, we demonstrate that the vertically integrated firm will adopt an inefficient sourcing rule when there are alternative, but inferior input suppliers.