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On the Cost-vs-Quality Tradeoff in Make-or-Buy Decisions

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  • Andersson, Fredrik

    ()
    (Department of Economics, Lund University)

Abstract

The make-or-buy decision is analyzed in a simple two-task principal-agent model. There is a cost-saving/quality tradeoff in effort provision. The principal faces a dichotomous choice between weak ("make") and strong ("buy") cost-saving incentives for the agent; the dichotomy is due to an incomplete-contracting limitation necessitating that one party be residual claimant. Choosing "buy" rather than "make" leads to higher cost-saving effort and -- in a plausible "main case" -- to lower quality effort; this in spite of stronger direct quality-provision incentives in the former case.

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File URL: http://project.nek.lu.se/publications/workpap/Papers/WP10_2.pdf
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Bibliographic Info

Paper provided by Lund University, Department of Economics in its series Working Papers with number 2010:2.

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Length: 19 pages
Date of creation: 26 Mar 2010
Date of revision:
Handle: RePEc:hhs:lunewp:2010_002

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Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund,Sweden
Phone: +46 +46 222 0000
Fax: +46 +46 2224613
Web page: http://www.nek.lu.se/en
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Keywords: make-or-buy decision; manipulation; outsourcing;

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  1. Lindqvist, Erik, 2007. "Will Privatization Reduce Costs?," Working Paper Series in Economics and Finance 660, Stockholm School of Economics.
  2. Oliver Hart & Andrei Shleifer & Robert Vishny, 1996. "The Proper Scope of Government: Theory and an Application to Prisons," Harvard Institute of Economic Research Working Papers 1778, Harvard - Institute of Economic Research.
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  4. Domberger, Simon & Jensen, Paul, 1997. "Contracting Out by the Public Sector: Theory, Evidence, Prospects," Oxford Review of Economic Policy, Oxford University Press, vol. 13(4), pages 67-78, Winter.
  5. Andersson, Fredrik, 2009. "Make-or-buy decisions and the manipulability of performance measures," Working Papers 2009:16, Lund University, Department of Economics, revised 20 Nov 2009.
  6. Daron Acemoglu & Michael Kremer & Atif Mian, 2003. "Incentives in Markets, Firms and Governments," NBER Working Papers 9802, National Bureau of Economic Research, Inc.
  7. Corneo, Giacomo & Rob, Rafael, 2003. "Working in public and private firms," Journal of Public Economics, Elsevier, vol. 87(7-8), pages 1335-1352, August.
  8. Gibbons, Robert, 2005. "Four forma(lizable) theories of the firm?," Journal of Economic Behavior & Organization, Elsevier, vol. 58(2), pages 200-245, October.
  9. Baker, George P, 1992. "Incentive Contracts and Performance Measurement," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 598-614, June.
  10. Patrick Bajari & Steven Tadelis, 1999. "Incentives versus Transaction Costs: A Theory of Procurement Contracts," Working Papers 99029, Stanford University, Department of Economics.
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