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Idiosyncratic Investments, Outside Opportunities and the Boundaries of the Firm

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  • Kerschbamer, Rudolf
  • Maderner, Nina
  • Tournas, Yanni
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    Abstract

    This paper adopts the incomplete contracting perspective to study a firm’s continuous choice between producing an essential input in-house (full integration), contracting part of the production out (tapered integration), and contracting all of the production out (non-integration), when (i) an idiosyncratic capacity investment is required to produce the essential input and (ii) under non-integration, outside opportunities are better. We show that the firm’s boundary choice depends crucially on its commitment power. If the firm can pre-commit to a particular provision mode, tapered integration will be chosen more frequently. Also, with commitment power the firm will never subcontract only a small portion of its input needs. In-house capacity is in general smaller and outside capacity larger if the firm can pre-commit. Total capacity is never larger in the commitment than the non-commitment case.

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    Bibliographic Info

    Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2558.

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    Date of creation: Sep 2000
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    Handle: RePEc:cpr:ceprdp:2558

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    Related research

    Keywords: Boundary Choice; Incomplete Contracts; Relation-Specific Investment; Transaction Costs;

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    References

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    1. Hart, Oliver D. & Moore, John, 1990. "Property Rights and the Nature of the Firm," Scholarly Articles 3448675, Harvard University Department of Economics.
    2. Bolton, Patrick & Whinston, Michael D, 1993. "Incomplete Contracts, Vertical Integration, and Supply Assurance," Review of Economic Studies, Wiley Blackwell, vol. 60(1), pages 121-48, January.
    3. Hanson, Gordon H, 1995. "Incomplete Contracts, Risk, and Ownership," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(2), pages 341-63, May.
    4. Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 691-719, August.
    5. Chiu, Y Stephen, 1998. "Noncooperative Bargaining, Hostages, and Optimal Asset Ownership," American Economic Review, American Economic Association, vol. 88(4), pages 882-901, September.
    6. David De Meza & Ben Lockwood, 1998. "Does Asset Ownership Always Motivate Managers? Outside Options And The Property Rights Theory Of The Firm," The Quarterly Journal of Economics, MIT Press, vol. 113(2), pages 361-386, May.
    7. Hart, Oliver & Moore, John, 1999. "Foundations of Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 115-38, January.
    8. Williamson, Oliver E, 1979. "Transaction-Cost Economics: The Governance of Contractural Relations," Journal of Law and Economics, University of Chicago Press, vol. 22(2), pages 233-61, October.
    9. Maskin, Eric & Tirole, Jean, 1999. "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 83-114, January.
    10. Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law and Economics, University of Chicago Press, vol. 21(2), pages 297-326, October.
    11. Lewis, Tracy R & Sappington, David E M, 1991. "Technological Change and the Boundaries of the Firm," American Economic Review, American Economic Association, vol. 81(4), pages 887-900, September.
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