Decision Sciences Journal
Volume 29, Number 4
Fall 1998
Outsourcing Decisions and Managerial Incentives
Peter Chalos and Jaeyoung Sung
College of Business Administration, University of Illinois at
Chicago, 601 South Morgan Street, Chicago, IL 60607-7124
Abstract. An agency model is presented in which outsourcing
strictly dominates in-house production. We argue that firms outsource
in order to improve managerial incentives. Conditions are established
under which the firm is strictly better off with outsourcing.
The benefit of outsourcing, however, is constrained by the trade-off
between the incremental coordination costs of outsourcing and
the improved incentive structure. The optimal contract is also
shown to be a function of whether or not the firm is publicly
held. For a publicly held firm, the contract is constant. For
a privately held supplier, the contract is likely to be of a
cost-sharing type. These findings offer preliminary incentive
explanations for commonly observed outsourcing practices.
Subject Areas: Agency Problems, Make/Buy Models, Outsourcing,
and Supplier Partnerships. |