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Optimal Contract Orders and Relationship-Specific Investments in Vertical Organizations

  • Sarah Parlane

    (University College Dublin)

  • Ying-Yi Tsai

    (National University of Kaohsiung)

This 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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File URL: http://www.ucd.ie/t4cms/WP13_16.pdf
File Function: First version, 2013
Download Restriction: no

Paper provided by School Of Economics, University College Dublin in its series Working Papers with number 201316.

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Length: 31 pages
Date of creation: 01 Oct 2013
Date of revision:
Handle: RePEc:ucn:wpaper:201316
Contact details of provider: Postal: UCD, Belfield, Dublin 4
Phone: +353-1-7067777
Fax: +353-1-283 0068
Web page: http://www.ucd.ie/economics
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  1. Martin K Perry & Jozsef Sakovics, 2004. "Auctions for Split-Award Contracts," ESE Discussion Papers 90, Edinburgh School of Economics, University of Edinburgh.
  2. Juan Carluccio & Thibault Fally, 2012. "Global Sourcing under Imperfect Capital Markets," The Review of Economics and Statistics, MIT Press, vol. 94(3), pages 740-763, August.
  3. Joshua S. Gans, 2007. "VERTICAL CONTRACTING WHEN COMPETITION FOR ORDERS PRECEDES PROCUREMENT -super-* ," Journal of Industrial Economics, Wiley Blackwell, vol. 55(2), pages 325-346, 06.
  4. Pol Antras & Elhanan Helpman, 2004. "Global Sourcing," Journal of Political Economy, University of Chicago Press, vol. 112(3), pages 552-580, June.
  5. Costinot, Arnaud & Oldenski, Lindsay & Rauch, James, 2009. "Adaptation and the Boundary of Multinational Firms," CCES Discussion Paper Series 14, Center for Research on Contemporary Economic Systems, Graduate School of Economics, Hitotsubashi University.
  6. Yun, Mikyung, 1999. "Subcontracting relations in the Korean automotive industry: risk sharing and technological capability," International Journal of Industrial Organization, Elsevier, vol. 17(1), pages 81-108, January.
  7. Beata S. Javorcik & Mariana Spatareanu, 2009. "Tough Love: Do Czech Suppliers Learn from Their Relationships with Multinationals?," LICOS Discussion Papers 24909, LICOS - Centre for Institutions and Economic Performance, KU Leuven.
  8. Antràs, Pol & Rossi-Hansberg, Esteban, 2008. "Organizations and Trade," CEPR Discussion Papers 6965, C.E.P.R. Discussion Papers.
  9. James J. Anton & Dennis A. Yao, 1989. "Split Awards, Procurement, and Innovation," RAND Journal of Economics, The RAND Corporation, vol. 20(4), pages 538-552, Winter.
  10. repec:hrv:faseco:4784029 is not listed on IDEAS
  11. ITO Banri & TOMIURA Eiichi & WAKASUGI Ryuhei, 2007. "Dissecting Offshore Outsourcing and R&D: A Survey of Japanese Manufacturing Firms," Discussion papers 07060, Research Institute of Economy, Trade and Industry (RIETI).
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