Outsourcing Decisions and Managerial Incentives*

Abstract

An agency model is presented in which outsourcing strictly dominates in-house production. We argue that firms outsource in order to improve managerial incentives. Conditions are established under which the firm is strictly better off with outsourcing. The benefit of outsourcing, however, is constrained by the trade-off between the incremental coordination costs of outsourcing and the improved incentive structure. The optimal contract is also shown to be a function of whether or not the firm is publicly held. For a publicly held firm, the contract is constant. For a privately held supplier, the contract is likely to be of a cost-sharing type. These findings offer preliminary incentive explanations for commonly observed outsourcing practices.Subject Areas: Agency Problems, Make/Buy Models, Outsourcing, and Supplier Partnerships.

The rise and fall of Public–Private Partnerships in China: a path-dependent approach

“…In PPPs, private actors might make strategic bids, deliver lower service quality where this is not easy to spot, reduce maintenance activities or increase the service price in obscure ways. Meanwhile, public actors may offer public transport facility as serious alternatives that badly compromise the viability of private facilities, they might intentionally reduce monitoring efforts in the contract period, or disclose confidential information to those actors that bribe them in tendering process (Boyne, 1998;Chalos and Sung, 1998;Crawford, 2003;Boehm and Olaya, 2006;Dalen et al, 2006;Rooks et al, 2006). These modes of behavior on either side jeopardize partnerships.…”

Information technology outsourcing and organizational restructuring: An explanation of their effects on firm value

“…They explain this trend by pointing to firms' increasing recognition that greater IS expertise can be obtained externally, rather than internally, and that, moreover, this expertise is a key driver of economic competitive advantage (Yang & Huang, 2000). Others have observed that, in general, outsourcing decisions of publicly traded firms are more likely to be of the cost-saving type (Chalos & Sung, 1998).…”

Alliances and cost declaration

“…The extent of opportunistic behavior in misreporting costs and its effect on the success of the alliance is not clear; the direction of the bias in cost misreporting and its effect on the alliance is not a trivial problem. To our knowledge no analytical work has been done in this context.Management literature (Cross, 1995;Chalos and Sung, 1998;Monczka et al, 1998) provides anecdotal evidence that successful alliances exchange information on input costs and that the exchange is an important determinant of alliance success. In particular, Cross (1995) discusses the importance of access to suppliers' information in the successful outsourcing of British Petroleum's Information Technology Department activities.…”