Property Rights, Firm Boundaries, and R&D Inputs

This paper provides an explanation of the role of intellectual property rights (IPRs) in information-intensive vertical supply relationships. Specifically, we explore the connection between stronger property rights and the enhanced viability of specialized (versus vertically integrated) input suppliers under incomplete contracts and information spillovers. Information spillovers arise due to the supplier’s effort to customize its generalized technology to the specific needs of the buyer. We start by modeling a tradeoff between incentives and two types of information spillovers: "synergies," in which joint efforts reveal new applications of existing technology; and "leakage," or disclosure of existing information. Whereas incentives for customization are higher under specialization, integration internalizes spillovers and prevents rent dissipation. IPRs favor specialization by reducing buyer opportunism, and ceteris paribus, leakage favors integration relative to synergies. We extend our basic results to analysis of buyouts and spinoffs, and assay an extensive body of empirical evidence that provides broad support for our approach.