JournalofLaw,Economics,andOrganizationvol.4,no.1Spring1988VERTICALINTEGRATIONASORGANIZATIONALOWNERSHIP:THEFISHERBODY-GENERALMOTORSRELATIONSHIPREVISITEDIamgratefultoHaroldDemsetz,KevinJames,TimothyOpler,andOliverWilliamsonforusefulcomments.IamgratefultoHaroldDemsetz,KevinJames,TimothyOpler,andOliverWilliamsonforusefulcomments.BenjaminKleinUniversityofCalifornia,LosAngelesIhavealwaysconsideredmyworkwithArmenAlchianandRobertCrawford(1978)onverticalintegrationtorepresentanextensionofCoase’sclassicarticleon“TheNatureoftheFirm.”Byfocusingonthe“hold-up”potentialthatiscreatedwhenfirm-specificinvestmentsaremadebytransactors,orwhatwecalledtheappropriationofquasi-rents,IbelievedwehadelucidatedoneaspectoftheCoasianconceptoftransactioncostsassociatedwithmarketexchange.Wehypothesizedthatanincreaseinfirm-specificinvestments,byincreasingthemarkettransactioncostsassociatedwithahold-up,increasedthelikelihoodofverticalintegration.Thisrelationshipbetweenfirm-specificinvestments,markettransactioncosts,andverticalintegrationwasillustratedbyexaminingthecontractualdifficultiesthatexistedwhenGeneralMotorspurchasedautomobilebodiesfromFisherBodyandthecorrespondingbenefitsthatwerecreatedwhenthepartiesverticallyintegrated.ItisclearfromCoase’slecturesthatheconsidersouranalysisnottorepresentanextensionofhisearlierwork,butrathertobeanalternative,incorrectexplanationforverticalintegration(1988:lecture3).Coaserecognizesthatanincreaseinthequasi-rentsyieldedbyfirm-specificinvestmentscreatesahold-uppotential.However,hearguesthatthereisnoreasontobelievethatthissituationismorelikelytoleadtoverticalintegrationthantoalong-termcontract.Althoughlong-termcontractsareimperfect,opportunisticbehaviorisusuallyeffectivelyhandledinthemarketplace,accordingtoCoase,byafirm'sneedtotakeaccountoftheeffectofitsactionsonfuturebusiness.Coaseclaimsthatbeforewritinghisclassicpaperheexplicitlyconsideredopportunisticbehaviorasamotiveforverticalintegration,inparticularasitappliedtotheGeneralMotors-FisherBodycase,andexplicitlyrejectedit.Unfortunately,Coase’srejectionoftheopportunismanalysisisbasedupontoosimplifiedaviewofthemarketcontractingprocessandtoonarrowaviewofthetransactioncostsassociatedwiththatprocess.AmorecompleteanalysisofhowverticalintegrationsolvedtheopportunisticbehaviorproblemintheFisherBody-GeneralMotorscaseprovidesinsightintothenatureofthetransactioncoststhatareassociatedwiththemarketcontractingprocessandhowverticalintegrationreducesthesecosts.Theprimarytransactioncostssavedbyverticalintegrationarenotthe“inkcosts”associatedwiththenumberofcontractswrittenandexecutedbut,rather,arethecostsassociatedwithcontractuallyinducedhold-ups.Theanalysisindicatesthathold-uppotentialsarecreatednotsolelyfromtheexistenceoffirm-specificinvestments,butalsofromtheexistenceoftherigidlysetlong-termcontracttermsthatareusedinthepresenceofspecificinvestments.Verticalintegration,byshiftingownershipofthefirm'sorganizationalasset,createsadegreeofflexibilityandavoidsthiscontractuallycreatedhold-uppotential,therebyresultinginsignificanttransactioncostsavings.1.LONG-TERMCONTRACTSASSOLUTIONSTOANDCAUSESOFHOLD-UPPROBLEMSCoaseiscorrectinbelievingthatinmanycasescontractualarrangements,ratherthanverticalintegration,canbeandareusedtosolvehold-upproblems.Forexample,considerthecaseofbuildingahouseonapieceofland.Itisobviousthatyouwouldnotbuildthehouseonlandyouhadonlyrentedforashortterm.Afterthelandleaseexpiredthelandownercouldholdyouupforthequasi-rentsonyourhouseinvestment.However,thisdoesnotmeanthatyouneednecessarilyowntheland,thatis,verticallyintegrate,tosolvethisproblem.Thehold-upproblempotentiallycouldbesolvedbytheuseofalong-termrentalcontractonthelandnegotiatedbeforethehousewasconstructed.Sincelandisthetypeofinputwhereanticipatedqualityvariationsareverysmallornonexistent,along-termrentalcontractiscertainlyafeasiblewaytominimizethehold-uppotentialwithoutverticalintegration.Thelong-termexclusivedealingcontractadoptedbyFisherBodyandGeneralMotorsin1919canbeexplainedasananalogouscontractualmeanstoavoidahold-uppotentialwithoutverticalintegration.1SinceFisherBodyhadtomakeaninvestmenthighlyspecifictoGeneralMotorsinthestampingmachinesanddiesnecessarytoproducetheautomobilebodiesdemandedbyGeneralMotors,asignificanthold-uppotentialwascreated.AfterFishermadetheThecontractualagreementbetweenFisherBodyandGeneralMotorscanbefoundintheminutesoftheBoardofDirectorsofFisherBodyCorporationforNovember7,1919.AnalysisofthiscaseistakeninpartfromKlein,Crawford,andAlchian(308-10).investment,GeneralMotorscouldhaveattemptedtoappropriatethequasi-rentsfromtheinvestmentbythreateningtoreducetheirdemandforFisher-producedbodies,oreventoterminateFishercompletely,ifpricewerenotadjusteddownward.Theexclusivedealingclause,whichrequiredGeneralMotorsoveraten-yearperiodtobuyalltheirclosedmetalbodiesfromFisherBody,limitedtheabilityofGeneralMotorstoopportunisticallythreatenFisherBodyinthismanner.ThecontractualarrangementtherebyreducedFisherBody'srelianceonGeneralMotors'reputationandencouragedFisherBodytomakethespecificinvestment.Althoughtheten-yearexclusivedealingcontractualarrangementprotectedFisheragainstaGeneralMotorshold-up,itcreatedapotentialforFishertoholdupGeneralMotors.FishercouldtakeadvantageoftherequirementthatGeneralMotorscouldnotpurchaseelsewherebyincreasingpriceordecreasingquality.ThecontractattemptedtoprotectGeneralMotorsagainstthisreversehold-uppotentialbyspecifyingaformulabywhichpricewouldbesetovertheten-yearperiodatacompetitivelevel.Inaddition,inafurtherattempttominimizethepotentialFisherhold-upofGeneralMotors,thecontractalsoincludedmost-favorednationprovisionssothatthepricecouldnotbegreaterthanwhatFisherBodychargedotherautomobilemanufacturersfor“similar”bodies.Sucha“priceprotection”clausepreventsahold-upbecauseapriceincreaseordecreasetoanybuyerisguaranteedtobegiventoallbuyers.Hence,establishedbuyersthatare“l(fā)ocked-in”byaspecificinvestmentoracontractualcommitmentareprotectedbytheseller'sdesiretomakeprofitablenewsales.Inspiteoftheexistenceofalong-termcontractualarrangementwithexplicitlysetpriceandpriceprotectionclauses,thereisstillsomeprobabilitythatahold-upmayoccur.Thisisbecausenotallelementsoffutureperformancearespecifiedinthecontract.Duetouncertaintyandthedifficultyofspecifyingallelementsofperformanceinacontractuallyenforceableway,contractswillnecessarilybeincompletetoonedegreeoranother.Thiscreatesthepossibilityfortransactorstotakeadvantageofthecontracttohold-uptheirtransactingpartner.Forexample,thelong-termlandrentalcontractinthehouseconstructionexamplemaypermitthelandownertohold-upthehouseownerbyopportunisticallycontrollingthewatersupplytothehouse,orbyfailingtobuildawalltopreventerosionofthelandunderthehouse,orbyclosingaroadonthelandforclaimedrepairsandtherebythreateningtorestrictaccesstothehouse.Eventhoughcontractsareincomplete,thereputationsofthetransactingpartieslimittheeconomicfeasibilityofhold-upthreats.Itisthemagnitudeofthesereputationsandthecorrespondingcoststhatcanbeimposedonatransactorthatattemptsahold-upthatdefinewhatcanbecalledthe“selfenforcingrange”ofthecontractualrelationship.Transactingpartiesentercontractualarrangementsbymakingspecificinvestmentsandsettingcontracttermsinsuchawaysothattheyarelikelytobewithinthisself-enforcingrangewhereahold-upwillnotoccur.However,thereissomeprobabilitythatmarketconditionsmaychange(forexample,thevalueofthequasi-rentsaccruingtooneofthepartiesunexpectedlyincreases)sothatitpaysforonetransactortohold-uptheotherinspiteofthelossofreputation.2Forexample,intheGeneralMotors-FisherBodycasedemandfortheclosedmetalbodiesmanufacturedbyFisherincreaseddramatically.Whenthecontractwasenteredintoin1919thedominantproductionprocessforautomobilesconsistedofindividuallyconstructed,largelywooden,openbodies;closedmetalbodieswereessentiallyanovelty.Demandforclosedmetalbodiesgrewextremelyrapidlyandby1924accountedformorethan65percentofGeneralMotors'automobileproduction.3Thisshiftindemandmovedthecontractualarrangementoutsideoftheself-enforcingrangeandmadeitprofitableforFishertoholdupGeneralMotors.AlthoughFishercouldhavetakenadvantageofmanyimperfectlyspecifiedtermsofthecontractualarrangement,suchasdeliverytimesorqualitycharacteristics,FishereffectivelyheldupGeneralMotorsbyadoptingarelativelyinefficient,highlylabor-intensivetechnologyandbyrefusingtolocatethebodyproducingplantsadjacenttoGeneralMotorsassemblyplant.4Thishold-upmechanismhadtheadvantage,fromFisher'sviewpoint,ofincreasingThisprobabilisticequilibriumdiffersfromtheanalysisinKlein,Crawford,andAlchian,wherehold-upswereassumednottobepresentinlong-runequilibriumandexistedsolelybecauseoftransactormyopiaorignorance.KenneyandKleinpresentsadiscussionofthe“self-enforcingrange”andthisequilibrium,togetherwiththeimplicationsoftheanalysisforcontractlaw.SixteenthAnnualReport,GeneralMotorsCorporation,yearendedDecember31,1924.SeedepositiontestimonyofAlfredP.Sloan,Jr.inUnitedStatesv.Dupont&Co.,366U.S.316(1961),186-90(April28,1952)and2908-14(March14,1953).profitabilitysincethecontractuallyspecifiedpriceformulasetpriceequaltoFisher’s“variablecost”plus17.6percent,placinga17.6percentprofitupchargeonFisher’slaborandtransportationcosts.TheprofitupchargepresumablywasdesignedtocoverFisher’santicipatedcapitalcosts,whichmayhavebeendifficulttoisolateandmeasureforGeneralMotorsshipmentsand,therefore,wereunreimbursableunderthecontractformula.Thecontractmayappeartobeimperfect,butitwasonlydeficientexpost.Ifdemandhadnotgrownsorapidly,Fisher’sreputation(thatis,lossoffuturebusinesswithGeneralMotorsandpossiblyotherautomobilemanufacturers)combinedwiththemostfavorednationclausemayhavebeenaneffectiveconstraintonFisherBodybehavior.However,thelargeincreaseindemandplacedFisher’sshort-runhold-uppotentialofGeneralMotors,evenwithFisherbeingforcedtogiveupnewandfuturesales,outsidetheself-enforcingrange.TheFisherBody-GeneralMotorscaseillustratesthatwhilelong-termcontracttermsandtransactorreputationsmaypreventhold-upsandencouragespecificinvestmentsbytyingthehandsofthetransactingparties,long-termcontracttermsmayalsocreatehold-upproblems.Therefore,itismisleadingtoassert,asCoasedoes,that“opportunisticbehaviorisusuallyeffectivelychecked”inthemarketbylong-termcontractsandtheexistenceoftransactorreputations.Althoughtheassertionistrue,amorecompleteanalysismustrecognizethattransactorreputationsarelimitedandthatcontractsmayactuallycreate,ratherthansolve,hold-upproblems.Itwasthelong-term,fixedpriceformula,exclusivedealingcontractadoptedbythetransactorsinresponsetothepotentialGeneralMotorshold-upofFisherthatcreatedtheenormousFisherhold-uppotentialofGeneralMotors.Themagnitudeofthiscontractuallycausedhold-upwaslikelymuchgreaterthanthequasi-rentsontheGeneralMotors-specificinvestmentsmadebyFisherwhichthecontractwasattemptingtoprotectinthefirstplace.Althoughwritingdownbindingcontracttermsmayeconomizeonlimitedbrandnamecapitalandreducetheprobabilityofbeingoutsidetheselfenforcingrange,therigidityoflong-termcontracttermsmaycreateamuchlargerhold-uppotentialifeventsactuallyplacethepartiesoutsidetheselfenforcingrange.Toavoidthisrigiditytransactorsmayintentionallyleavetheircontractsincompleteandtherebygivethemselves“anout”ifmarketconditionsget“outofline.”Itisthiscontractuallyinducedhold-uppotentialandthecostsassociatedwithrigidex-postincorrectcontractterms,illustratedsoforcefullyintheFisherGeneralMotorscase,thatrepresentthemajortransactioncostsofusingthemarketmechanismtosolvethehold-upproblem.Thesetransactioncostsincludetherealresourcestransactorsdissipateinthecontractualnegotiationandrenegotiationprocessintheattempttocreateandexecuteahold-up.Transactorswillsearchforaninformationaladvantageovertheirtransactingpartnersandattempttonegotiateex-antecontracttermsthatcreatehold-uppotentials,thatis,thataremorelikelytoimplyex-postsituationswherecontracttermsarefavorablyincorrect.Oncesuchafavorablyincorrectsituationarises,transactorswilldissipaterealresourcesduringtherenegotiationprocessintheattempttoconvincetheirtransactingpartnerthatahold-uppotentialdoesexist.IntheFisher-GeneralMotorscasetheserenegotiationtransactioncostsconsistedofthecostsassociatedwithimproperplantplacementandlowcapital-intensityofproductionbeforeverticalintegrationoccurred.5Thesetransactioncostsassociatedwiththeuseofalong-termcontractrepresentthetheoreticalreasonwhythepresenceoffirm-specificinvestmentsaremorelikelytoleadtoverticalintegration.Specificinvestmentscreatethenecessityforlong-termcontractualtermswhich,inturn,implytherentdissipatingtransactioncostsassociatedwiththepossibilityofcontractuallycreatedhold-ups.Intheabsenceofspecificinvestments,long-termcontracttermsareunnecessaryandspotcontractscanbeused.Sincethecostsassociatedwithverticalintegrationaregenerallyincentive-typecoststhatareunrelatedtothelevelofspecificinvestments,verticalintegrationwillbemorelikelythegreaterthelevelofspecificinvestments.Thegreaterthelevelofspecificinvestmentsandhencethegreaterthepotentialcostsofusingthemarket(asInadditiontothetransactioncostsassociatedwithnegotiatingcontractualarrangementsandthetransitionalcostsassociatedwiththerenegotiatingprocesswhenthesearrangementsdonotworkoutinpractice,therearethesocialcostsassociatedwithtransactorsnotmakingspecificinvestmentsandenteringcontractualarrangementstobeginwith.Transactorsanticipatetherent-dissipatingtransactioncostsassociatedwithcontractualnegotiationandrenegotiationbecausetheyrecognizethelimitstotheirreputationcapital,theuncertaintyoftheworld,andthenecessaryimperfectionsofcontracts.Therefore,independentofanyriskaversion,transactorswillavoidenteringcontractualarrangementswherethereisasignificantprobabilitythatthearrangementwillnotworkout.Theequilibriumcontractualarrangementsthattransactorsvoluntarilyadoptinthemarketplacemayappear,consistentwithCoase’sassertion,tohandleopportunisticbehavior--inthesensethatweareunlikelytoobserveopportunismoccurringveryfrequently.However,wedonotseeallthespecificinvestmentsnotmadeandthecontractualmoreexplicitandrigidcontractualmechanismsmustbedevisedtoprotectthespecificinvestment),thegreaterthelikelihoodthatverticalintegrationwillbethesolution.2.PHYSICALCAPITALVS.HUMANCAPITALVerticalintegrationistheforminwhichthehold-upofGeneralMotorsbyFisherBodyeventuallytookplace,withGeneralMotorsacquiringtheFisherBodystockownedbyFisherattermsthatwerehighlyfavorabletoFisher.WhydidnotGeneralMotorsmerelymakealumpsumcashpaymenttoFisherandrenegotiatethecontract,fixingambiguoustermsandhopingthatanotherlargeunanticipatedeventwouldnotoccurinthefuturetoshocktherelationshipoutoftheself-enforcingrange?OnereasonisthatthechangeindemandtoclosedmetalbodiesmadeFisheramuchmoreimportantspecializedinputsuppliertoGeneralMotors,withtheFisherhold-uppotentialreachingessentiallytheentireGeneralMotorsindustry-specificinvestment.Inprinciple,withanex-postincorrectcontract,FishercouldpotentiallyholdupGeneralMotorsfortheirentireautomobilemanufacturinganddistributionorganization.Thisenormoushold-uppotentialwouldimplyextremelylargerent-dissipatingtransactioncostsduringthecontractualnegotiationandrenegotiationprocessasGeneralMotorsattemptedtoprotectagainstandFisherattemptedtotakeadvantageofthehold-uppossibilities.arrangementsnotadoptedwhentransactorsanticipateasignificantprobabilityofbeingoutsideVerticalintegrationappearstoavoidthesetransactioncostsbyeliminatingthesecondtransactor.Thisisobviousforcasesofphysicalcapital,suchasthehouseconstruction-landownershipexample,whereahold-up,bydefinition,becomesimpossiblewithverticalintegration.Itiscaseslikethesethatleadtotheobviousconclusionthatverticalintegrationwillmorelikelybeusedwhenthehold-uppotential,thatis,thequasi-rentsfromfirm-specificinvestments,arelarge.AsJoskow(1988)convincinglydemonstrates,thisinsightregardingtheeconomicmotivationforownershipoffirm-specificphysicalcapitalhassignificantempiricalrelevance.However,manyreal-worldexamplesinvolvehumancapitalandnotmerelyphysicalcapitalastheimportantfirm-specificasset.6Sincethespecifichumancapitalisembodiedinindividualswhobylawcannotbeownedandwhohavethepotentialtobehaveopportunisticallyunderanyalternativeorganizationalarrangement,verticalintegrationdoesnoteliminatetheothertransactorandthehold-upproblem.Insuchcasesitisunclearexactlywhatgainsareentailedbyverticalintegration.Tounderstandthegainsfromverticalintegrationinthecontextofhumancapital,theeconomicquestionshouldbephrasednot(aswehavedoneinthehouseconstruction-landownershipcase)aswhethertoownorrentanasset,but,asCoaseessentiallyphrasedit,aswhethertomakeorbuyaninput.Theformertheself-enforcingrange.See,forexample,thediscussioninKlein,Crawford,andAlchian(313-19)andWilliamson(240-45).questionappliesonlytophysicalcapitalwhilethelatterquestionappliestohumancapital.Whenafirmbuysaninputinthemarketplace,itgenerallydoesnotownthephysicalcapitalassociatedwithitsproduction.Afirmthatproducesaninputitselfalsomaynotownthephysicalcapitalassociatedwithitsproduction(forexample,thebuildingwherethefirmhasitsoffices).However,asweshallsee,afirmthatmakesratherthanbuysaninputgenerallyhasaparticularrelationshipwiththefirm-specifichumancapital.TheseissuescanbefocusedbyconsideringtheFisherBody-GeneralMotorscaseagain.Ifthehold-upproblemwerebasedsolelyontheGeneralMotors-specificphysicalcapitalinvestmentsmadebyFisherBodyandhadnothingtodowithFisherBodyhumancapital,GeneralMotorscouldhaveownedtheirowndiesandstampingmachinesandletFisherusethiscapitaltomakeautobodiesforthem,avoidingthehold-upproblemwhiletakingadvantageofwhatevercostadvantageFisherpossessedinproducingbodies.7OneproblemwiththissolutionisthattheextentoftheGeneralMotors-specificphysicalcapitalinvestmentsislikelytobemuchgreaterthanmerelythediesandstampingequipment.Thereare,forexample,complementaryphysicalCoasediscussesthisasaparticularcontractualsolutiontothehold-upproblem(1988:lecture1).SeealsoMonteverdeandTeece.Fisher’scostadvantagewasunlikelyduetoeconomiesofscaleintheproductionprocess.Evidenceforthisisthefactthat,afterdemandgrowthandintegration,FishersuppliedbodiessolelytoGeneralMotors.ThisisonedifferencebetweentheFisherBodycaseandtheA.O.SmithcasediscussedbyCoase(1988:lecture3).Thereappearstobesignificantlygreatereconomiesofscaleinproducingautomobileframesthanproducingautomobilebodies,withSmithsupplyingframesthenandnowtomultipleautomobilemanufacturers,therebyraisingthecostofverticalintegrationasasolutiontothehold-upproblem(seeStigler).Itisalsoimportanttonotethattheinvestmentinautomobileframeproductionis,apparently,lessbuyer-specificthantheinvestmentinautomobilebodyproduction.capitalinvestmentsthatmustbemadebyFisherinplant,withtheassociatedquestionsofplantlocationandtheassurancetoFisherofcontinuedGeneralMotorsdemandforthefacility.Thesequestionspresumablywouldhavetobehandledbycontract.Toavoidcontractualrigidityandtheinducedhold-upproblemsassociatedwithex-postincorrectcontracttermsGeneralMotorscouldownallthephysicalcapitalandmerelycontractwithFishertoruntheoperation.WhilesuchanarrangementwouldcreatemarginaldistortionsregardingtheuseoftheGeneralMotorscapitalequipmentbyFisher,itwouldappeartosolvethehold-upproblemiftheproblemwerebasedsolelyonspecificphysicalcapitalinvestments.However,muchofthespecificinvestmentnecessarytoproduceautomobilebodiesconsistsofFisherhumancapitalinvestmentsthat,bydefinition,cannotbeownedbyGeneralMotors,GeneralMotorscanfinanceFisher’shumancapitalinvestmentsbutwouldrequiresomelong-termfixedpricecontractualcommitmenttopreventFisherfromthreateningtoterminatetherelationshipifGeneralMotorsdidnotmakealumpsumpaymenttothemequaltothequasi-rentsfromthehumancapitalinvestment.Verticalintegration,inthesenseofmakingFisheranemployee,ratherthananindependentcontractor,doesnoteliminatethepotentialhold-up.Asopposedtophysicalcapital,thespecializedhumancapitalwouldpresumablystillbeownedbyFisherevenafterGeneralMotors'verticalintegration.Ratherthanownership,along-termcontractualarrangement,withitsassociatedrigiditiesandpotentialhold-upproblems,mustbeusedbythetransactors.8Since,bydefinition,onecannotownhumancapital,howdidtheverticalintegrationofGeneralMotorswithFisherreducethehold-upproblem?Asopposedtothecaseofphysicalcapital,verticalintegrationdidnoteliminatetheFisherbrothers.AfterverticalintegrationGeneralMotorsnolongerboughtbodiesfromFisherBodyCorporation.AfterverticalintegrationGeneralMotors“made”bodieswiththeassistanceofFisher.However,didmakingtheFisherbrothersemployeescomparedtobeingindependentcontractorschangethingsinanyessentialway?AlthoughGeneralMotorswouldnowowntheplantsandpresumablybeabletotelltheFisherbrotherswheretolocatethem,theFisherbrothersbecameemployeemanagerswiththeabilitytoholdupGeneralMotorsfortheirhumancapital-specificinvestmentsbythreateningmodificationonsomeotherdimension.3.VERTICALINTEGRATIONASORGANIZATIONALOWNERSHIPAlthoughtheuseofanemployeeratherthananindependentcontractorarrangementmayimplyimportantlegaldifferencesandhencedifferentconstraintsonthecontractingprocess,suchasthecaseofterminationbytheForexample,onecontracttermthatisusedinemploymentarrangementsintheentertainmentindustry,wheretheemployermaymakeasubstantialtransactor-specificinvestment,isarightoffirstrefusalclause.Thisclausereducesthecredibilityofhold-upthreatssinceitrequirestheemployeeattemptingtoincreasehiswagebytheamountofthequasi-rentsfromtheemployer’sinvestmenttothreatentoquitworkingcompletely,ratherthanmerelytothreatentoquitthefirmemployerandtherequiredloyaltyoftheemployee,IagreewithCoasethattheemployer-employeecontractdoesnotrepresenttheessenceofafirm.9ThetransitionoftheFisherbrothersfromindependentcontractorstoemployeesdoesnotexplainwhatGeneralMotorsgainedthroughverticalintegration.VerticalintegrationnotonlymadetheFisherbrothersemployeesofGeneralMotors,butalsoconvertedalltheemployeesofFisherBodyCorporationintoemployeesofGeneralMotors.GeneralMotorsmovedfrom“buying”automobilebodiesto“making”automobilebodiesbyobtainingownershipoftheFisherBodyorganization,includingallthelaborcontractsofthecooperatingworkersinthatorganizationandalltheknowledgeofhowtomakeautomobilescontainedinthatorganization.Itisthissenseofowningafirm'ssetofinterdependentlaborcontractsandthefirm-specificknowledgeembodiedintheorganization'steamofemployeesthatanownerofafirmcanownthefirm'shumancapital.10andworkelsewhere.SeeCoase(1988:lecture3)whereheidentifiesthisasthemainweaknessofhis1937article.Theconceptofspecificknowledgewhichaffectsafirm'sproductiontechnologyandwhichisvestedinandtransferablewiththefirmhasbeendiscussedbynumerousauthors.Rosennotesthatsuchafirm-specificinformationassetmaybecreatedovertimebythediscoveryoftradeconnectionsandtheassemblyofanefficient“productionteam”andpresentsamodelwherespecificknowledgeisacquiredthrough(orasaby-productof)afirm'sproductionexperience.AsimilarconceptisdevelopedinPrescottandVisscherandisrelatedtotheevolutionarytheoryofthefirmpresentedbyNelsonandWinter.TheimportanceofinformationaccumulationwithinthefirmasakindofprogressfunctionwasoriginallydiscussedbyAlchian(1959)andArrow.Thisconceptmayexplainwhybankruptcylawprovisions,whicharedesignedtopreventtheproductionteamfromdisbanding,makeeconomicsense.Whilephysicalassetsgenerallymaybesalvageable,bankruptcy,accompaniedbythediscontinuanceofafirm'soperations,maydestroytheorganizationalassetsofthefirm.Theanalysisalsoprovidesaneconomicjustificationforthe“failingfirm”defenseinmergerlaw.Verticalintegrationm