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Optimal Contract Orders and Relationship-Specific Investments in Vertical Organizations

  • Sarah Parlane
  • Ying-Yi Tsai

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

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Date of creation: Oct 2013
Date of revision:
Handle: RePEc:ucn:wpaper:201316
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  1. Carluccio, Juan & Fally, Thibault, 2010. "Global Sourcing under Imperfect Capital Markets," CEPR Discussion Papers 7868, C.E.P.R. Discussion Papers.
  2. 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.
  3. 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.
  4. 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).
  5. Pol Antras & Elhanan Helpman, 2004. "Global Sourcing," Journal of Political Economy, University of Chicago Press, vol. 112(3), pages 552-580, June.
  6. 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.
  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. 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.
  9. Rossi-Hansberg, Esteban & Antras, Pol, 2009. "Organizations and Trade," Scholarly Articles 3199064, Harvard University Department of Economics.
  10. repec:hrv:faseco:4784029 is not listed on IDEAS
  11. 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.
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