Toward an integrated theory of the firm: The interplay between internal organization and vertical integration

Research summary: Two central issues in strategic management are the determination of a firm's internal delegation and its vertical boundaries. Despite the importance of these issues, there is scant analysis concerning their interaction. Using a comprehensive database of the construction industry, we show that vertical integration positively influences the centralization decision and that the main mechanism driving this relationship is an improvement in the hierarchically coordinated adaptation of firm activities when complexity and uncertainty are high. We also observe that centralization is negatively related to the extent of relational contracts between principals and agents, and positively related to an exogenous increase in the cost of employee layoffs. Our results suggest that managers cannot consider firm boundaries and internal organization to be independent decisions. Managerial summary: We ask whether a firm's decision about vertically integrating or outsourcing its activities affects the choice of centralizing or delegating its internal decision-making process. Our statistical analysis shows that firms with more vertical integration tend to centralize the decision-making process and that firms that outsource more tend to decentralize more. Why? Vertical integration enables the use of centralized authority to coordinate activities that interact intensively. Accordingly, we found that the positive influence of vertical integration on centralization is especially significant in more complex and uncertain environments, when the need for coordination is higher. Thus, our results suggest that managers should choose vertical integration considering its effect on internal decision-making processes, particularly when coordination is important. Copyright © 2015 John Wiley & Sons, Ltd.