Outsourcing Decisions and Managerial Incentives*

Outsourcing Decisions and Managerial Incentives* 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. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Decision Sciences Wiley

Outsourcing Decisions and Managerial Incentives*

Decision Sciences, Volume 29 (4) – Sep 1, 1998

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Publisher
Wiley
Copyright
Copyright © 1998 Wiley Subscription Services, Inc., A Wiley Company
ISSN
0011-7315
eISSN
1540-5915
DOI
10.1111/j.1540-5915.1998.tb00881.x
Publisher site
See Article on Publisher Site

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.

Journal

Decision SciencesWiley

Published: Sep 1, 1998

Keywords: ; ; ;

References

  • The design of contracts: Evidence from Japanese subcontracting
    Kawasaki, S.; McMillan, J.
  • The core competence of the corporation
    Prahalad, C.; Hamel, G.

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