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Optimal Contract Orders and Relationship-Specific Investments in Vertical Organizations

Author

Listed:
  • Sarah Parlane
  • Ying-Yi Tsai

Abstract

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.

Suggested Citation

  • Sarah Parlane & Ying-Yi Tsai, 2013. "Optimal Contract Orders and Relationship-Specific Investments in Vertical Organizations," Working Papers 201316, School of Economics, University College Dublin.
  • Handle: RePEc:ucn:wpaper:201316
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    File URL: http://hdl.handle.net/10197/4811
    File Function: First version, 2013
    Download Restriction: no

    References listed on IDEAS

    as
    1. Arnaud Costinot & Lindsay Oldenski & James Rauch, 2011. "Adaptation and the Boundary of Multinational Firms," The Review of Economics and Statistics, MIT Press, pages 298-308.
    2. Beata S. Javorcik & Mariana Spatareanu, 2009. "Tough Love: Do Czech Suppliers Learn from their Relationships with Multinationals?," Scandinavian Journal of Economics, Wiley Blackwell, pages 811-833.
    3. Pol Antràs & Esteban Rossi-Hansberg, 2009. "Organizations and Trade," Annual Review of Economics, Annual Reviews, vol. 1(1), pages 43-64, May.
    4. Arnaud Costinot & Lindsay Oldenski & James Rauch, 2011. "Adaptation and the Boundary of Multinational Firms," The Review of Economics and Statistics, MIT Press, pages 298-308.
    5. Martin K. Perry & JÛzsef S·kovics, 2003. "Auctions for Split-Award Contracts," Journal of Industrial Economics, Wiley Blackwell, vol. 51(2), pages 215-242, June.
    6. Beata S. Javorcik & Mariana Spatareanu, 2009. "Tough Love: Do Czech Suppliers Learn from their Relationships with Multinationals?," Scandinavian Journal of Economics, Wiley Blackwell, pages 811-833.
    7. 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, June.
    8. Yun, Mikyung, 1999. "Subcontracting relations in the Korean automotive industry: risk sharing and technological capability," International Journal of Industrial Organization, Elsevier, pages 81-108.
    9. Pol Antras & Elhanan Helpman, 2004. "Global Sourcing," Journal of Political Economy, University of Chicago Press, vol. 112(3), pages 552-580, June.
    10. Juan Carluccio & Thibault Fally, 2012. "Global Sourcing under Imperfect Capital Markets," The Review of Economics and Statistics, MIT Press, pages 740-763.
    11. James J. Anton & Dennis A. Yao, 1989. "Split Awards, Procurement, and Innovation," RAND Journal of Economics, The RAND Corporation, pages 538-552.
    12. repec:hrv:faseco:4784029 is not listed on IDEAS
    13. Kaoru Hosono & Koji Sakai & Kotaro Tsuru, 2009. "Consolidation of Banks in Japan: Causes and Consequences," NBER Chapters,in: Financial Sector Development in the Pacific Rim, East Asia Seminar on Economics, Volume 18, pages 265-309 National Bureau of Economic Research, Inc.
    14. Jérôme Coffinet & Adrian Pop & Muriel Tiesset, 2010. "Predicting Financial Distress in a High-Stress Financial World: The Role of Option Prices as Bank Risk Metrics," Working Papers hal-00547744, HAL.
    15. Juan Carluccio & Thibault Fally, 2012. "Global Sourcing under Imperfect Capital Markets," The Review of Economics and Statistics, MIT Press, pages 740-763.
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    Cited by:

    1. Daly, Michael & Delaney, Liam & Doyle, Orla & Fitzpatrick, Nick & O'Farrelly, Christine, 2014. "Can Early Intervention Policies Improve Well-being? Evidence from a randomized controlled trial," SIRE Discussion Papers 2015-03, Scottish Institute for Research in Economics (SIRE).

    More about this item

    Keywords

    Moral Hazard; Vertical Organization; Supply Base Management; Contract Order Size; Relationship-specific Investment; Strategic Outsourcing;

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