DP15970 On the Optimality of Outsourcing when Vertical Integration can Mitigate Information Asymmetries

Author(s): Patrick W. Schmitz
Publication Date: March 2021
Keyword(s): Incomplete Contracts, Make-or-buy decision, Outsourcing, private information, Property rights approach
JEL(s): D23, D82, D86, L24, M11
Programme Areas: Organizational Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15970

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.