Vertical Integration for Quality Signaling

In the presence of consumers' incomplete information of firms' ability to produce quality components, we analyze firms' incentive to commit to a long-term relationship as a way to convince consumers about forming a high-type pair. In contrast to the result of no brand leverage obtained by Choi and Jeon (2007), our analysis demonstrates that a "brand-named" firm can restore its leverage by committing to a long-term relationship. To overcome the time inconsistency problem in a long-term contract, firms may utilize vertical integration with relation-specific investment. This signaling motivation for vertical integration is different from the explanations that currently exist.