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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. Arnaud Costinot & Lindsay Oldenski & James Rauch, 2011. "Adaptation and the Boundary of Multinational Firms," The Review of Economics and Statistics, MIT Press, vol. 93(1), pages 298-308, February.
  2. Beata S. Javorcik & Mariana Spatareanu, 2009. "Tough Love: Do Czech Suppliers Learn from Their Relationships with Multinationals?," Working Papers Rutgers University, Newark 2009-004, Department of Economics, Rutgers University, Newark.
  3. Pol Antràs & Elhanan Helpman, 2003. "Global Sourcing," NBER Working Papers 10082, National Bureau of Economic Research, Inc.
  4. Juan Carluccio & Thibault Fally, 2008. "Global sourcing under imperfect capital markets," PSE Working Papers halshs-00586005, HAL.
  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, 06.
  6. Pol Antràs & Esteban Rossi-Hansberg, 2008. "Organizations and Trade," NBER Working Papers 14262, National Bureau of Economic Research, Inc.
  7. repec:hrv:faseco:4784029 is not listed on IDEAS
  8. 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).
  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. 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.
  11. 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.
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