Technical efficiency and the vertical boundaries of the firm: theory and evidence

This article provides a theoretical and empirical analysis of the relationship between firms’ technical efficiency and the vertical organization of production. Technical inefficiency is explicitly introduced as the source of firms’ heterogeneity in a Bertrand–Nash model of industry competition: the main prediction of the model is that the most efficient firms choose vertical integrated structures and the less-efficient ones choose disintegrated structures. The empirical part of the article rests on a stochastic frontier analysis (SFA) in a sample of about 400 Italian machine tool (MT) builders, and the result supports the prediction of the theoretical model.