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Choosing between Foreign Direct Investment and International Subcontracting. A Model of a Multinational Firm's Decision in a Context of Moral Hazard

Author

Listed:
  • Rosa Forte

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

  • António Brandão

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

Abstract

The present paper develops a moral hazard model applied to a multinational firm (MNF)'s decision between foreign direct investment (FDI) and international subcontracting. We compare the results of the moral hazard model, characterized by the fact that the MNF is not able to control operations performed by the subcontractor firm, with the traditional model, which considers symmetric information. We conclude that the uncertainty associated with the subcontractor firm's behaviour, in spite of increasing the preference of the MNF to engage in FDI, does not change the optimal decision, which continues to be to subcontract. The exception occurs in the case that the subsidiary stands as more efficient than the subcontractor firm.

Suggested Citation

  • Rosa Forte & António Brandão, 2005. "Choosing between Foreign Direct Investment and International Subcontracting. A Model of a Multinational Firm's Decision in a Context of Moral Hazard," CEF.UP Working Papers 0506, Universidade do Porto, Faculdade de Economia do Porto.
  • Handle: RePEc:por:cetedp:0506
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    Cited by:

    1. Tattara, Giuseppe, 2010. "Choosing between foreign investment and subcontracting: Strategies of Italian firms in Romania," MPRA Paper 23787, University Library of Munich, Germany.

    More about this item

    Keywords

    Foreign direct investment; International subcontracting; Moral hazard;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • L24 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Contracting Out; Joint Ventures

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