Does market concentration motivate pulp and paper mills to vertically integrate?

Abstract

Following sound economic theory, paper mills vertically integrate into pulp production, partly because internalizing the production of their inputs allows them to avoid transaction costs. Higher market concentration, a proxy of higher asset specificity and transaction costs, should encourage vertical integration in the pulp and paper industry. However, this relationship has not been robust in previous studies or in our replication with updated FPL-UW data. Upon a deeper analysis of the data, this study should clarify the mechanism by which transaction cost can induce vertical integration in this particular industry, which does not have well-defined intermediate goods markets. In order to specify the pulp markets where paper mills are likely to trade, we construct a mill-specific concentration measure as a substitute to traditional regional concentration measures. We also narrow our sample to mills producing free sheet paper, the most profitable paper grade in this industry. With such model refinement, this research exhibits a significantly positive correlation between transaction cost and vertical integration.