Idiosyncratic Investments, Outside Opportunities and the Boundaries of the Firm

Rudolf Kerschbamer, Yanni Tournas and Nina Maderner

No 2558, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This paper adopts the incomplete contracting perspective to study a firm?s continuous choice between producing an essential input in-house (full integration), contracting part of the production out (tapered integration), and contracting all of the production out (non-integration), when (i) an idiosyncratic capacity investment is required to produce the essential input and (ii) under non-integration, outside opportunities are better. We show that the firm?s boundary choice depends crucially on its commitment power. If the firm can pre-commit to a particular provision mode, tapered integration will be chosen more frequently. Also, with commitment power the firm will never subcontract only a small portion of its input needs. In-house capacity is in general smaller and outside capacity larger if the firm can pre-commit. Total capacity is never larger in the commitment than the non-commitment case.

Keywords: Boundary choice; Relation-specific investment; Incomplete contracts; Transaction costs (search for similar items in EconPapers)
JEL-codes: C23 L14 L22 L23 (search for similar items in EconPapers)
Date: 2000-09
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Journal Article: Idiosyncratic investments, outside opportunities and the boundaries of the firm (2002)
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