On the Optimality of Outsourcing when Vertical Integration can Mitigate Information Asymmetries

Schmitz, Patrick W. (2021): On the Optimality of Outsourcing when Vertical Integration can Mitigate Information Asymmetries. Published in: Economics Letters , Vol. 202, No. 109823 (2021)

Abstract

Consider a buyer and a seller who have agreed to trade an intermediate good. It is ex-post efficient to adapt the good to the prevailing state of the world. The seller has private information about the costs of adapting the good. In the case of non-integration, the buyer has no possibility to verify claims that the seller makes about her costs. In the case of vertical integration, the buyer can verify evidence about the costs that the seller might be able to provide. Even though we assume no further differences between the ownership structures, it turns out that the parties may prefer non-integration.

• Item Type: MPRA Paper
• Language: English
• Keywords: Incomplete contracts; Make-or-buy decision; Property rights approach; Private information; Outsourcing
• Subjects: D - Microeconomics > D2 - Production and Organizations > D23 - Organizational Behavior ; Transaction Costs ; Property Rights; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information ; Mechanism Design; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D86 - Economics of Contract: Theory; L - Industrial Organization > L2 - Firm Objectives, Organization, and Behavior > L24 - Contracting Out ; Joint Ventures ; Technology Licensing; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M1 - Business Administration > M11 - Production Management

References

Aghion, P., Tirole, J., 1994. The management of innovation. Quarterly Journal of Economics 109, 1185--1209.

Arrow, K.J., 1975. Vertical integration and communication. Bell Journal of Economics, 173--183.

Coase, R.H., 1937. The nature of the firm. Economica 4, 386--405.

Dewatripont, M., Tirole, J., 1999. Advocates. Journal of Political Economy 107, 1--39.

Fudenberg, D., Tirole, J., 1991. Game Theory. Cambridge, MA: MIT Press.

Gibbons, R., 2005. Four formal(izable) theories of the firm. Journal of Economic Behavior and Organization 58, 200--245.

Goldlücke, S., Schmitz, P.W., 2014. Investments as signals of outside options. Journal of Economic Theory 150, 683--708.

Goltsman, M., 2011. Optimal information transmission in a holdup problem. Rand Journal of Economics 42, 495--526.

Green, J.R., Laffont, J.-J., 1986. Partially verifiable information and mechanism design. Review of Economic Studies 53, 447--456.

Grossman, S.J., Hart, O.D., 1986. The costs and benefits of ownership: A theory of vertical and lateral integration. Journal of Political Economy 94, 691--719.

Hart, O.D., 1995. Firms, Contracts and Financial Structure. Oxford: Oxford University Press.

Hart, O., 2011. Thinking about the firm: A review of Daniel Spulber's The Theory of the Firm. Journal of Economic Literature 49, 101--113.

Hart, O.D., Moore, J., 1990. Property rights and the nature of the firm. Journal of Political Economy 98, 1119--1158.

Hart, O., Moore, J., 1999. Foundations of incomplete contracts. Review of Economic Studies 66, 115--138.

Hart, O., Moore, J., 2007. Incomplete contracts and ownership: Some new thoughts. American Economic Review 97, 182--186.

Hart, O., Moore, J., 2008. Contracts as reference points. Quarterly Journal of economics 123, 1--48.

Hoppe, E.I., Schmitz, P.W., 2010. The costs and benefits of additional information in agency models with endogenous information structures. Economics Letters 107, 58--62.

Hoppe, E.I., Schmitz, P.W., 2013. Contracting under incomplete information and social preferences: An experimental study. Review of Economic Studies 80, 1516--1544.

Iossa, E., Martimort, D., 2015. Pessimistic information gathering. Games and Economic Behavior 91, 75--96.

Laffont, J.-J., 1999. Political economy, information and incentives. European Economic Review 43, 649--669.

Martimort, D., 1999. The life cycle of regulatory agencies: Dynamic capture and transaction costs. Review of Economic Studies 66, 929--947.

Mohan, V., 2014. A note on the property rights theory and the ex ante value of information. Bulletin of Economic Research 66, 205--215.

Mori, Y., 2017. A formal model of firm boundaries and haggling. Economics Letters 156, 15--17.

Mori, Y., 2020. Ex ante investment, ex post adaptation, and joint ownership. Economics Letters 187, 108927.

Myerson, R.B., 1982. Optimal coordination mechanisms in generalized principal-agent problems. Journal of Mathematical Economics 10, 67--81.

Riley, J., Zeckhauser, R., 1983. Optimal selling strategies: When to haggle, when to hold firm. Quarterly Journal of Economics 98, 267--289.

Riordan, M., 1990. What is vertical integration? In: Aoki, M., Gustafsson, B., Williamson, O.E. (eds.), The Firm as a Nexus of Treaties, London: Sage, 94--111.

Rosenkranz, S., Schmitz, P.W., 1999. Know-how disclosure and incomplete contracts. Economics Letters 63, 181--185.

Schmitz, P.W., 2006. Information gathering, transaction costs, and the property rights approach. American Economic Review 96, 422--434.

Schmitz, P.W., 2007. Optimal selling strategies when buyers may have hard information. European Economic Review 51, 859--870.

Schmitz, P.W., 2008a. Joint ownership and the hold-up problem under asymmetric information. Economics Letters 99, 577--580.

Schmitz, P.W., 2008b. Incomplete contracts, the hold-up problem, and asymmetric information. Economics Letters 99, 119--122.

Schmitz, P.W., 2017. Asymmetric information and the property rights approach to the theory of the firm. Economics Letters 159, 96--99.

Schmitz, P.W., 2021. Contracting under adverse selection: Certifiable vs. uncertifiable information. Journal of Economic Behavior and Organization 182, 100--112.

Segal, I., Whinston, M.D., 2013. Property rights. Handbook of Organizational Economics, 100--158.

Su, A.P.-J., 2017a. Information revelation in the property right theory of the firms. International Journal of Industrial Organization 52, 133--164.

Su, A.P.-J., 2017b. Information acquisition and the equilibrium incentive problem. Journal of Economics and Management Strategy 26, 231--256.

Tadelis, S., Williamson, O.E., 2013. Transaction cost economics. Handbook of Organizational Economics, 159--193.

Tirole, J., 1986. Hierarchies and bureaucracies: On the role of collusion in organizations. Journal of Law, Economics, and Organization 2, 181--214.

Williamson, O.E., 1975. Markets and Hierarchies: Analysis and Antitrust Implications. New York: Free Pres.

Williamson, O.E., 1985. The Economic Institutions of Capitalism. New York: Free Pres.

Williamson, O.E., 2000. The new institutional economics: Taking stock, looking ahead. Journal of Economic Literature 38, 595--613.

Williamson, O.E., 2002. The theory of the firm as governance structure: From choice to contract. Journal of Economic Perspectives 16, 171--195.

Ye, B., Li, S., 2018. Competitive contracts with productive information gathering. Journal of Economics 124, 1--17.