Global Sourcing if Contracts are Reference Points

Bohdan Kukharskyy

No 129, Working Papers from Bavarian Graduate Program in Economics (BGPE)

Abstract: This paper presents econometric evidence for a link between a country’s level of egalitarianism and its inward foreign direct investment. In order to provide a theoretical rationale for this relationship, I embed Hart and Moore’s (2008) novel contractual foundation into a simple model of global sourcing with culturally dissimilar countries. Entrepreneurs can cooperate with foreign suppliers under two contractual modes: rigid and flexible. If suppliers consider original contracts as reference points and future is uncertain, a fundamental tradeoff arises between these two modes. By stipulating a range of possible outcomes, a flexible contract allows for future adaptation but is associated with ex post haggling cost. By specifying a single outcome, a rigid contract eliminates future disagreement but precludes beneficial adjustments to the occurring shocks. The key message of this paper is twofold: Due to lower haggling cost, the degree of contractual flexibility is higher in egalitarian countries. If future is uncertain, these countries are more attractive for international investors than less egalitarian ones.

Keywords: Foreign direct investment; cross-country cultural differences; egalitarianism; risk; contracts as reference points; haggling; contractual rigidity vs. flexibility (search for similar items in EconPapers)
JEL-codes: D03 D23 D63 F23 L23 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2012-11
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https://bgpe.cms.rrze.uni-erlangen.de/files/2023/0 ... Reference-Points.pdf First version, 2012 (application/pdf)

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