Optimal Contract Orders and Relationship-Specific Investments in Vertical Organizations
AbstractThis paper characterizes the optimal contracts issued to suppliers when delivery is subject to disruptions and when they can invest to reduce such a risk. When investment is contractible dual sourcing is generally optimal because it reduces the risk of disruption. The manufacturer (buyer) either issues symmetric contracts or selects one supplier as a major provider who invests while the buffer supplier does not. An increased reliance on single sourcing or on a major supplier is optimal under moral hazard. Indeed, we show that order consolidation increases the manufacturer’s profits because it serves as an incentive device in inducing investment.
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Bibliographic InfoPaper provided by School Of Economics, University College Dublin in its series Working Papers with number 201316.
Length: 31 pages
Date of creation: 01 Oct 2013
Date of revision:
Moral Hazard; Vertical Organization; Supply Base Management; Contract Order Size; Relationship-specific Investment; Strategic Outsourcing;
Find related papers by JEL classification:
- D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
- D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
- L24 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Contracting Out; Joint Ventures
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-10-05 (All new papers)
- NEP-COM-2013-10-05 (Industrial Competition)
- NEP-CTA-2013-10-05 (Contract Theory & Applications)
- NEP-HRM-2013-10-05 (Human Capital & Human Resource Management)
- NEP-MIC-2013-10-05 (Microeconomics)
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