Asset Specificity and Vertical Integration

Asset specificity is usually considered to be an argument for vertical integration. The main idea is that specificity induces opportunistic behavior, and that vertical integration reduces the cost of preventing opportunism. In this paper I show that asset specificity can be an argument for non‐integration. In a repeated‐game model of self‐enforcing relational contracts, it is shown that when parties are non‐integrated, increasing degrees of asset specificity make it possible to design relational contracts with higher‐powered incentives.