We develop a model in which the heterogeneous firms in an industry choose their modes of organization and the location of their subsidiaries or suppliers. We assume that the principals of a firm are constrained in the nature of the contracts they can write with suppliers or employees. Our main result concerns the sorting of firms with diï¬€erent productivity levels into diï¬€erent organizational forms. We use the model to examine the implications of falling trade costs for the relevant prevalence of outsourcing and foreign direct investment.
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