DP10620 Culture and Global Sourcing

Author(s): Yuriy Gorodnichenko, Bohdan Kukharskyy, Gérard Roland
Publication Date: May 2015
Keyword(s): cultural distance, global sourcing, organization of multinational firms, property rights, vertical integration
JEL(s): F14, F23, P14, Z1
Programme Areas: International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10620

This paper develops a model of global sourcing with culturally dissimilar countries. Production of final goods requires the coordination of decisions between the headquarter of a multinational firm and managers of their component suppliers. Managers of both units are assumed to have strong beliefs about the right course of action and are reluctant to adjust their decisions. We characterize the optimal allocation of decision rights across firms when contracts are incomplete. Our theoretical model delivers two key predictions: the incentive of a firm to integrate (rather than outsource) its input supply is decreasing in the cultural distance between the home and the host country and decreasing in trade costs between the two countries. Combining data from the U.S. Census Bureau's Related Party Trade with various measures for cultural distance and trade cost, we find empirical evidence strongly supportive of these two predictions.