Incomplete Contracts, Risk, and Ownership

Gordon Hanson

International Economic Review, 1995, vol. 36, issue 2, 341-63

Abstract: This paper develops a model of ownership based on incomplete contracts, specific investments, and risk and tests the model using data on industrial subcontracting in Mexico. The choice of ownership structure involves a trade-off between minimizing holdup risk and spreading natural risk. Concentrating ownership under one party reduces her exposure to holdup but increases her exposure to environmental uncertainty. Using data on Mexican apparel subcontracting, the author finds evidence that supports the model: the share of production subcontracted is high in market segments where demand is highly variable and low in market segments where manufacturers make large relationship-specific investments. Copyright 1995 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Date: 1995
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