RESEARCH ARTICLE Endogenous vertical structure and trade policy in an import-competing market Ki-Dong Lee 1 | Kangsik Choi 2 | DongJoon Lee 3,4 1 Faculty of Economics & Commerce, School of Social Science, Keimyung University, Daegu, Republic of Korea 2 Graduate School of International Studies, Pusan National University, Pusan, Republic of Korea 3 Faculty of Economics, Osaka Sangyo University, Osaka, Japan 4 Graduate School of Management, Nagoya University of Commerce & Business, Nagoya, Japan Correspondence Kangsik Choi, Graduate School of International Studies, Pusan National University, Busandaehak-ro, 63 beon-gil 2, Geumjeong-gu, Pusan 46241, Republic of Korea. Email: choipnu@pusan.ac.kr We examine the endogenous determination of a vertical market in an import- competing market with import tariff. We show that if firms commit to vertical organi- zation before the government's commitment to trade policy, the home and foreign firms choose vertical separation and vertical integration, respectively, at equilibrium under Bertrand competition. Under Cournot competition, the subgame perfect Nash equilibrium entails both firms separating their retailers. Comparing profits between Bertrand competition to Cournot competition, we find that upstream manufacturer's profit can be higher under Bertrand competition with integration than under Cournot competition with separation when comparing foreign upstream manufacturer's profit. JEL CLASSIFICATION F12; F13; L13 1 | INTRODUCTION In an oligopolistic market, the strategic advantages of vertical separa- tion are well known. Strategic vertical separation is discussed in papers on vertical relations between manufacturers and distributors (e.g., Bonanno & Vickers, 1988; Gal-Or, 1990; Rey & Stiglitz, 1995; Buehler & Schmutzler, 2008; Li & Shuai, 2017). Most of the literature on vertical separation in distribution channels presumes a “domestic” market and focuses on symmetric vertical market structures. Thus, in equilibrium, these studies on strategic vertical relations obtain sym- metric market structures, except for Buehler and Schmutzler (2008). 1 Considering the growing competition among firms and the trade barriers in a global market framework, it is somewhat naïve to apply the research results for the domestic market to the global market. In fact, in the real world, numerous firms compete in the international market in a diverse vertical structure. Examples of industries where vertical separation is a key feature of their organizational structure include aircraft, computers, and audio/video systems (Matsushima & Mizuno, 2013). Despite widespread vertical separation, there are many industry- and firm-level examples of vertical integration in real- ity. Some of the best known examples are in the oil industry: Multina- tional oil companies such as ExxonMobile, Royal Dutch Shell, and BP have adopted vertically integrated structures, meaning they have engaged in drilling and extracting crude oil, transporting it around the world, refining it into petroleum products, and distributing the fuel to company-owned retail stations for sale to consumers. Apple Inc. pro- vides a good example of a vertical integration strategy in the smartphone retail sector. Apple retails most of its products via Apple stores, which are a chain of retail stores owned and operated by Apple Inc. Zara, a Spanish clothing company, has more than 1,000 outlets worldwide. Unlike companies such as Gap and H&M, which purchase their clothes from outside suppliers, Zara produces mostly its own clothing, with around 60% of its goods made in-house. Recent advances in international trade theory emphasize firms' strategic behavior under imperfect competition and its implication for trade policy but have paid little attention to the interaction between firms' vertical organizational structure of different countries and trade policies. The literature on strategic trade policy provides researchers with clues to explore the impact of vertical market structure on trade policies. Reflecting that diverse vertical market structures are a com- mon phenomenon in the international market, the literature exploring the validity of trade policies for the upstream and downstream mar- kets has been growing. This is an area referred to as strategic trade policy under vertically related markets (see Footnote 2). Most studies have successfully justified the validity of trade policies under vertically related market but have failed to explain why firms' vertical organiza- tion structure is diverse and how this vertical structure is affected by trade policies. The main reason is that they confine their views to a Received: 15 December 2019 Revised: 8 April 2020 Accepted: 19 May 2020 DOI: 10.1002/mde.3193 Manage Decis Econ. 2020;1–15. wileyonlinelibrary.com/journal/mde © 2020 John Wiley & Sons, Ltd. 1