The optimal length of contracts with application to outsourcing

This paper resolves three empirical puzzles in outsourcing by formalizing the adaptation cost of long-term performance contracts. Side-trading with a new partner alongside a long- term contract (to exploit an adaptation-requiring investment) is usually less effective than switching to the new partner when the contract expires. So long-term contracts that prevent holdup of specific investments may induce holdup of adaptation investments. Contract length therefore trades of specific and adaptation investments. Length should increase with the importance and specificity of self-investments, and decrease with the importance of adaptation investments for which side-trading is ineffective. My general model also shows how optimal length falls with cross-investments and wasteful investments.Contract length, market forces, incomplete contracts, holdup

Global Sourcing under Imperfect Capital Markets

We develop a simple model to study the interactions between a supplier’s financial constraints and contract incompleteness in a vertical relationship. Production complexity increases the extent of contract incompleteness and the hold-up problem, which generates a cost when the supplier needs financial participation from the downstream firm. Vertical integration alleviates the impact of financial constraints but reduces the supplier’s incentives. We apply the model to an analysis of multinational firms’ sourcing strategies and predict that (1) complex and specific inputs are more likely to be sourced from financially developed countries and (2) multinationals are more likely to integrate suppliers located in countries with poor financial institutions, especially when trade involves complex goods. We examine and validate these predictions using firm-level trade data on multinational firms with operations in France. We provide evidence that financial development generates a comparative advantage in the supply of complex goods. Moreover, we find higher shares of intra-firm imports of complex inputs from countries with a lower level of financial development. The findings are robust to different measures of complexity and specificity, and are not driven by industry differences in fixed costs or traditional measures of external financial dependence. Quantitatively, we find that financial development is as important as contract enforcement in alleviating hold-up problems.Sourcing, FDI, financial constraints, contractual frictions.

International Sourcing, Product Complexity and Intellectual Property Rights

In this paper, we propose the technological complexity of a product and the level of Intellectual Property Rights (IPRs) protection to be the co-determinants of the mode through which multinational firms purchase their goods. We study the choice between intra-firm trade and outsourcing given heterogeneity at the product- (complexity), firm- (productivity) and country- (IPRs) level. Our findings suggest that the above three dimensions of heterogeneity are crucial for complex goods, where firms face a trade-off between higher marginal costs in the case of trade with an affiliate and higher imitation risks in the case of sourcing from an independent supplier. We test these predictions by combining data from a French firm-level survey on the mode choice for each transaction with a newly developed complexity measure at the product-level. Our fractional logit estimations confirm the proposition that although firms are generally reluctant to source highly complex goods from outside the firm’s boundaries, they do so when a strong IPR regime in the host country guarantees the protection of their technology.sourcing decision; product complexity; intellectual property rights; fractional logit estimation

Intellectual Property Rights, Product Complexity, and the Organization of Multinational Firms

This paper studies how the Intellectual Property Right (IPR) regime in destination countries influences the way multinationals structure the international organization of their production. In particular, we explore how multinationals divide tasks of different complexities across countries with different levels of IPR protection. The analysis studies the decision of firms between procurement from related parties and outsourcing to independents suppliers at the product level. It also breaks down outsourcing into two types by distinguishing whether or not they involve technology sharing between the two parties. We combine data from a French firm-level survey on the mode choice for each transaction with a newly developed complexity measure at the product level. Our results confirm that firms are generally reluctant to source highly complex goods from outside firm boundaries. By studying the interaction between product complexity and the IPR protection, we obtain that (i) for technology-sharing-outsourcing IPRs promote outsourcing of more complex goods to a destination country by guaranteeing the protection of their technology, (ii) for non-technology-related-outsourcing IPRs attract the outsourcing of less complex products that are more prone to reverse engineering and simpler to decodify and imitate.

Global sourcing under imperfect capital markets

We develop a simple model to study the interactions between a supplier's financial constraints and contract incompleteness in a vertical relationship. Production complexity increases the extent of contract incompleteness and the hold-up problem, which generates a cost when the supplier needs financial participation from the downstream firm. Vertical integration alleviates the impact of financial constraints but reduces the supplier's incentives. We apply the model to an analysis of multinational firms sourcing strategies and predict that (1) complex and specific inputs are more likely to be sourced from financially developed countries and (2) multinationals are more likely to integrate suppliers located in countries with poor financial institutions, especially when trade involves complex goods. We examine and validate these predictions using firm-level trade data on multinational firms with operations in France. We provide evidence that financial development generates a comparative advantage in the supply of complex goods. Moreover, we find higher shares of intra-firm imports of complex inputs from countries with a lower level of financial development. The findings are robust to different measures of complexity and specificity, and are not driven by industry differences in fixed costs or traditional measures of external financial dependence. Quantitatively, we find that financial development is as important as contract enforcement in alleviating hold-up problems.sourcing ; FDI ; financial constraints ; contractual frictions

International Sourcing, Product Complexity and Intellectual Property Rights

In this paper, we propose the technological complexity of a product and the level of Intellectual Property Rights (IPRs) protection to be the co-determinants of the mode through which multinational firms purchase their goods. We study the choice between intra-firm trade and outsourcing given heterogeneity at the product- (complexity), firm- (productivity) and country- (IPRs) level. Our findings suggest that the above three dimensions of heterogeneity are crucial for complex goods, where firms face a trade-off between higher marginal costs in the case of trade with an affiliate and higher imitation risks in the case of sourcing from an independent supplier. We test these predictions by combining data from a French firm-level survey on the mode choice for each transaction with a newly developed complexity measure at the product-level. Our fractional logit estimations confirm the proposition that although firms are generally reluctant to source highly complex goods from outside the firm’s boundaries, they do so when a strong IPR regime in the host country guarantees the protection of their technology.Sourcing Decision, Product Complexity, Intellectual Property Rights, Fractional Logit Estimation

International Sourcing, Product Complexity and Intellectual Property Rights

In this paper, we propose the technological complexity of a product and the level of Intellectual Property Rights (IPRs) protection to be the co-determinants of the mode through which multinational firms purchase their goods. We study the choice between intra-firm trade and outsourcing given heterogeneity at the product-(complexity), firm-(productivity) and country-(IPRs) level. Our findings suggest that the above three dimensions of heterogeneity are crucial for complex goods, where firms face a trade-off between higher marginal costs in the case of trade with an affiliate and higher imitation risks in the case of sourcing from an independent supplier. We test these predictions by combining data from a French firm-level survey on the mode choice for each transaction with a newly developed complexity measure at the product-level. Our fractional logit estimations confirm the proposition that although firms are generally reluctant to source highly complex goods from outside the firm’s boundaries, they do so when a strong IPR regime in the host country guarantees the protection of their technology.Sourcing decision, product complexity, intellectual property rights, fractional logit estimation

What factors determine the number of trading partners?

The purpose of the paper is to provide a simple model explaining buyer-supplier relationships and show what factors determine the number of trading partners. We show that when the supplier is able to determine the number of trading partners, the optimal number is small if the supplier's bargaining power with them is weak, the economy of scope in the supplier's variable costs is significant, and that in its sunk investment is weak. Investment may be greater when the number of trading partners is small. The results may be consistent with the formation of Japanese buyer-supplier relations.

Corporate decision-making in R&D outsourcing and the impact on internal R&D employment intensity

This article aims to assess whether firms’ strategies of R&D outsourcing determine changes in their internal R&D employment intensity. Four strategic decisions are investigated: to start, increase, decrease or stop outsourcing. It is found that internal R&D employment intensity decreases when firms decide to start, to increase, or to stop R&D outsourcing. However, this finding hides important differences according to the type and the location of the contractor. In general, firms prefer a mix of different types of contractors at different locations. Started outsourcing of R&D to research centers within the nation and increased R&D outsourcing to research centers within the region appear to decrease the internal R&D employment intensity. Decreasing outsourcing to national universities in another region also has a negative impact on internal R&D employment intensity. A corporate decision to stop R&D outsourcing to other firms within the nation but outside the region has a positive impact on the internal R&D employment intensity. The latter is the only effect that is not only statistically significant but is also substantial in magnitude

Bargaining power and supply base diversification

In this paper, the authors examine a supply base diversification problem faced by a buyer who periodically holds auctions to award short term supply contracts among a cohort of suppliers (i.e., the supply base). To mitigate significant cost shocks to procurement, the buyer can diversify her supply base by selecting suppliers from different regions. The authors find that the optimal degree of supply base diversification depends on the buyer’s bargaining power, i.e., the buyer’s ability to choose the auction mechanism. At one extreme, when the buyer has full bargaining power and thus can dictatorially implement the optimal mechanism, she prefers to fully diversify. At the other extreme, when the buyer uses a reverse English auction with no reserve price due to her lack of bargaining power, she may consider protecting herself against potential price escalation from cost-advantaged suppliers by using a less diversified supply base. The authors find that in general the more bargaining power the buyer has to control price escalation from cost-advantaged suppliers the more she prefers a diversified supply base. This insight is shown to be robust to correlation between regional costs, asymmetry across regions, and intermediate levels of bargaining power.supply base diversification; supplier; buyer; procurement; bargaining