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Quality of Institutions, Global Sourcing, and the Make-or-Buy Decision

  • Bohdan Kukharskyy
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    Do contractual institutions and a country’s level of trust interact in their impact on the international make-or-buy decision? By analyzing explicit and implicit contracting in a unified framework, I show that better formal contractibility may both facilitate and hinder relational contracting on a trust basis. If formal agreements crowd out first-best efficient relational contracts, firms’ profitability and consumers’ welfare decrease. In contrast, a higher level of trust unambiguously increases firm performance and a country’s attractiveness as an offshoring destination. I also show that improvements in the trust level are associated with largest reductions in intrafirm trade if formal contractibility is low. Lastly, this paper argues that models built on the simplifying assumption of ex ante lump-sum transfers between parties generally overestimate the prevalence of outsourcing vs. integration.

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    File Function: First version, 2012
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    Paper provided by Bavarian Graduate Program in Economics (BGPE) in its series Working Papers with number 128.

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    Length: 36 pages
    Date of creation: Nov 2012
    Date of revision:
    Handle: RePEc:bav:wpaper:128_kukharskyy
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