Relational contracts, which are informal agreements based on future relationships, are common within and between firms. This paper develops repeated-game models to show why and how relational contracts within firms (vertical integration) differ from those between firms (non-integration). Integration affects the parties' temptations to renege on a relational contract, thus influencing the best relational contract they can sustain. The integration decision can serve the parties' relationship. The paper also has implications for joint ventures, alliances, and networks, as well as the role of management within and between firms. Relational contracts help circumvent difficulties in formal contracting. They allow parties to use detailed knowledge of their specific situation and adapt to new information. However, they cannot be enforced by a third party and must be self-enforcing, as the value of the future relationship must be sufficiently large to prevent reneging. The paper develops repeated-game models of relational contracts both within and between firms. It shows that integration affects the parties' temptations to renege on a given relational contract. Thus, in a given environment, a desirable relational contract might be feasible under integration but not under non-integration (or the reverse). This result motivates a new perspective on vertical integration: a major factor in the vertical-integration decision is whether integration or non-integration facilitates the superior relational contract. The paper explores the implications of its main proposition by deriving five further results. Vertical integration is an efficient response to widely varying supply prices because integration reduces reneging temptations in such situations. High-powered incentives create bigger reneging temptations under integration than under non-integration, with the consequence that performance payments in relational incentive contracts will be smaller under integration than under (otherwise equivalent) non-integration. The optimal integration decision can depend on the discount rate and payoff levels. The paper also shows that a firm may be unable to improve upon even a mediocre spot-market outcome because the availability of the spot-market outcome as a fallback after reneging may render infeasible any desirable relational-employment contract. The paper discusses the implications of its findings for organizational forms, including joint ventures, strategic alliances, and business groups. It also explores the implications for internal organizational processes such as transfer pricing, capital allocation, compensation, and corporate governance. The paper argues that the focus on relational contracts suggests a natural role for managers in the economic theory of the firm: managers formulate, communicate, implement, and change relational contracts. Such management can be as important in relationships between firms as within.Relational contracts, which are informal agreements based on future relationships, are common within and between firms. This paper develops repeated-game models to show why and how relational contracts within firms (vertical integration) differ from those between firms (non-integration). Integration affects the parties' temptations to renege on a relational contract, thus influencing the best relational contract they can sustain. The integration decision can serve the parties' relationship. The paper also has implications for joint ventures, alliances, and networks, as well as the role of management within and between firms. Relational contracts help circumvent difficulties in formal contracting. They allow parties to use detailed knowledge of their specific situation and adapt to new information. However, they cannot be enforced by a third party and must be self-enforcing, as the value of the future relationship must be sufficiently large to prevent reneging. The paper develops repeated-game models of relational contracts both within and between firms. It shows that integration affects the parties' temptations to renege on a given relational contract. Thus, in a given environment, a desirable relational contract might be feasible under integration but not under non-integration (or the reverse). This result motivates a new perspective on vertical integration: a major factor in the vertical-integration decision is whether integration or non-integration facilitates the superior relational contract. The paper explores the implications of its main proposition by deriving five further results. Vertical integration is an efficient response to widely varying supply prices because integration reduces reneging temptations in such situations. High-powered incentives create bigger reneging temptations under integration than under non-integration, with the consequence that performance payments in relational incentive contracts will be smaller under integration than under (otherwise equivalent) non-integration. The optimal integration decision can depend on the discount rate and payoff levels. The paper also shows that a firm may be unable to improve upon even a mediocre spot-market outcome because the availability of the spot-market outcome as a fallback after reneging may render infeasible any desirable relational-employment contract. The paper discusses the implications of its findings for organizational forms, including joint ventures, strategic alliances, and business groups. It also explores the implications for internal organizational processes such as transfer pricing, capital allocation, compensation, and corporate governance. The paper argues that the focus on relational contracts suggests a natural role for managers in the economic theory of the firm: managers formulate, communicate, implement, and change relational contracts. Such management can be as important in relationships between firms as within.