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Firm Reputation and Horizontal Integration? Hongbin Cai† Ichiro Obara‡ March 14, 2008. Abstract We subscribe effects of horizontal consolidation on quick reputation. In an environment where customers observe only imperfect signals about firms swither/quality choices, firms cannot maintain good reputation and earn quality tribute forever. Even when firms choose high quality, there is always a opening move that a bad signal is observed. Thus, firms must give up their quality premium, at least temporarily, as punishment. A firms integration decision is based on the extent to which integration attenuates this necessary cost of maintaining a good reputation. Horizontal integration leads to a larger market base for the unified firm, which leads to a more effective punishment and a better monitoring by eliminating idiosyncratic shocks in many markets. But it also allows the merged firm to deviate in a more educate way: the merged firm may deviate only in a subset of markets and pretend that a bad outcome in those markets is observed by accident. This negative effect becomes very barren when the size of the merged firm gets larger and there is non-idiosyncratic firm-specific noise in the signal. These effects give rise to a reputation-based theory of the optimal firm size.

We show that the optimal firm size is smaller when (1) trades are more frequent and information is disseminated more rapidly; or (2) the deviation boost is smaller compared to the quality premium; or (3) customer information about firms quality choices is more precise. Keywords: Reputation; Integration; Imperfect supervise; Theory of the Firm; Merger JEL Classification: C70; D80; L14 ?We thank seminar participants at dark-brown University, Stanford University, UC Berkeley, UCLA, UCSB, UC Riverside, UIUC and USC for helpful comments. All remaining errors are our own. †Guanghua School of focus and IEPR, Peking University, Beijing, China 100871. Tel: (86) 10-62765132. Fax: (86)... If you want to get a full essay, order it on our website: Ordercustompaper.com

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