Internal vs. External Markets

National Bureau Of Economic Research Inc, Cambridge MA

Investigators

Abstract

This project is a theoretical and empirical investigation of the differences between internal and external product, capital and labor market transactions and the implications of these differences for firm behavior. The first project seeks to understand why some new business ventures are undertaken by established firms, while others are undertaken by start-up firms. The model presents an answer based on a key difference in the functioning of internal and external labor markets, namely the ability of internal labor markets to redeploy workers in the firm to other projects in the firm if the new venture fails. The model will then be used to analyze the level and efficiency of new firm formation; the characteristics of employees at new and established firms; and the type of work employees undertake at the two types of firms. The second project (joint with Sendhil Mullainathan, Department of Economics, MIT) seeks to understand the effects of vertical integration. If integration has no real effects, integrated and non-integrated firms should respond in the same way to external market shocks. This study examines whether this is indeed the case by analyzing the investment behavior of integrated and non-integrated petrochemical producers using a comprehensive 25-year database of over 4000 U.S. petrochemical plants. The preliminary results suggest that capacity investments by integrated firms are less sensitive than non-integrated firms to market shocks. The project considers several competing explanations of these findings, and outlines an empirical strategy for distinguishing among them.