Regulation, Vertical Integration and Sabotage

Abstract

We consider the incentive of a dominant firm that supplies a necessary input to a Bertrand-competitive differentiated products downstream industry to: (1) vertically integrate forward, and (2) raise its downstream rivals’ costs through non-price activities which we characterize generally as ‘sabotage’. We examine these incentives both in the absence and presence of a regulatory constraint on the upstream price. We find that, while an incentive for vertical integration is present regardless of the existence of the regulatory constraint, the incentive for sabotage emerges only in the presence of binding input price regulation. Welfare effects are also explored.