Outsourcing decisions and managerial incentives

Outsourcing decisions and managerial incentives

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Article ID: iaor20012406
Country: United States
Volume: 29
Issue: 4
Start Page Number: 901
End Page Number: 919
Publication Date: Sep 1998
Journal: Decision Sciences
Authors: ,
Keywords: outsourcing
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.

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