Vertical Integration and Cost of Private Debt

I examine the relationship between a firm’s degree of vertical integration (VI) and the cost of private debt. My study explores two channels: reduced dependence on the supply chain partners (Resource dependence theory) and decreased information friction. Using mediation analysis, I document that VI reduces customer/supplier concentration, reducing the focal firm’s dependence on supply chain partners and leading to a decline in the cost of borrowing. Further, using proxies such as the bullwhip effect, social capital score, analyst following, and forecast, I find that this association is more pronounced in environments with high information friction. Additionally, the association between VI and borrowing cost is stronger for cash-rich and large-sized firms. My study contributes to the VI and debt contracting literature by highlighting that savings in financing costs is a critical benefit that managers should incorporate before implementing the VI, and that lenders factor in
organizational structure changes in their loan contract terms.