Vertical integration and proprietary information transfers

Suppose that rival downstream producers of a final good contract with the s ame upstream supplier of an input and, in the process, reveal private infor mation. A vertical merger between the upstream supplier and one of the down stream firms maya dissipate the information advantage of the remaining down stream firms. The welfare consequences of such a merger and related informa tion sharing depend on the value of information, the benefits of integratio n aprt from information sharing, and the nature of upstream competition. In this paper, conditions are found under which owners of a vertically integr ated fir are better off breaking up into independent firms. This result may explain AT&T's recent spinoff of Lucent Technologies. Further results sugg est that a prohibition on information transfers, such as that often propose d by the Federal Trade Commission and Department of Justice as a precursor to approving vertical mergers, may actually reduce expected consumer surplu s and expected social welfare.