Ethics, Bounded Rationality, and IP Sharing in IT Outsourcing

Krishnan S. Anand () and Manu Goyal ()
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Krishnan S. Anand: Department of Operations and Information Systems, David Eccles School of Business, University of Utah, Salt Lake City, Utah 84112
Manu Goyal: Department of Operations and Information Systems, David Eccles School of Business, University of Utah, Salt Lake City, Utah 84112

Management Science, 2019, vol. 65, issue 11, 5252-5267

Abstract: Our dynamic model of information technology (IT) outsourcing integrates incomplete contracts, moral hazard, and adverse selection under both perfect and, more realistically, bounded rationality. In addition to the classical profit-maximizing firm unconstrained by ethics, we model an ethically constrained (but otherwise profit-maximizing) firm that honors its contractual obligations irrespective of legal restraints. We prove that under bounded rationality, the ethically constrained firm can obtain strictly greater profits than the unconstrained profit-maximizing firm, even when (i) the unconstrained firm has access to a superset of the ethical firm’s strategies and (ii) the ethical firm is unable to reveal its ethical commitment to its contracting partner anytime during the contractual relationship. Thus, a commitment to ethics, while of course being morally desirable, can lead to higher profits than the unbridled profit-maximization of classical economics. We also prove that ethics is foundational to both intellectual property (IP) sharing and reputation effects , two well-known facilitators of IT outsourcing. In fact, the mere possibility of ethical firms (a) forces across-the-board IP sharing even if it lowers profits and (b) induces even an ethically unconstrained firm to invest in developing a reputation for ethics. Our model provides a novel explanation, rooted in ethics, for why IT outsourcing is booming despite the formidable impediments of incomplete contracts, moral hazard, and adverse selection.

Keywords: information systems; IT policy and management; outsourcing; economics of IS; economics; game theory (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (3)

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