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Effects of Adverse Selection on a Multinational Firm's Decision on Where to Subcontract

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  • Rosa Forte

    ()
    (CETE, Faculdade de Economia, Universidade do Porto)

  • António Brandão

    ()
    (CETE, Faculdade de Economia, Universidade do Porto)

Abstract

The present paper analyses the multinational firm's decision on where to subcontract in a context of asymmetric information. When a multinational firm (MNF) intends to subcontract the production of a good to a foreign firm, it faces an adverse selection problem. In fact, at the outset, foreign firms (agents) have an information advantage relative to the MNF with respect to their true production costs, which is not available to the MNF (principal). Methodologically, we adapt the general model of adverse selection to the particular case of the choice of the country on where to subcontract. We then compare the equilibrium obtained with the one which would occur in a context absent of adverse selection. Furthermore, we analyze the sensibility of the equilibrium and of a MNF's profits to changes in the parameters of the model. Since the subcontracting relationship is, generally, materialised through the accomplishment of a contract between the MNF and the foreign firm, the decision of the country on where to subcontract relates to the choice of the best contract, from the MNF's point of view, to offer to the foreign firm. Adverse selection modelling outcomes justify and are coherent with empirical evidence such as, the diversity of countries that MNFs subcontract and the fast production relocation between countries.

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Bibliographic Info

Paper provided by Universidade do Porto, Faculdade de Economia do Porto in its series CEF.UP Working Papers with number 0504.

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Length: 32 pages
Date of creation: Sep 2005
Date of revision:
Handle: RePEc:por:cetedp:0504

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Keywords: International subcontracting; adverse selection; location;

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  1. Deborah L. Swenson, 2004. "Overseas Assembly and Country Sourcing Choices," NBER Working Papers 10697, National Bureau of Economic Research, Inc.
  2. Robert Feenstra, 2003. "Integration Of Trade And Disintegration Of Production In The Global Economy," Working Papers 986, University of California, Davis, Department of Economics.
  3. Katharine G. Abraham & Susan K. Taylor, 1993. "Firms' Use of Outside Contractors: Theory and Evidence," NBER Working Papers 4468, National Bureau of Economic Research, Inc.
  4. Vining, Aidan & Globerman, steven, 1999. "A conceptual framework for understanding the outsourcing decision," European Management Journal, Elsevier, vol. 17(6), pages 645-654, December.
  5. Das, Satya P, 1999. "Direct Foreign Investment versus Licensing," Review of Development Economics, Wiley Blackwell, vol. 3(1), pages 86-97, February.
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