The link between organizational choice and global input sourcing under sequential production

Abstract

This article analyzes the ways heterogenous firms procure their inputs in the presence of relationship‐specific investments and incomplete contracts. We first consider a closed economy in which firms decide how to structure their organization. Production is sequential and inputs (upstream and downstream) are sourced in the same order as production. While our closed‐economy setup is analogous to Antràs and Chor (Econometrica, 2013), there are two distinct features: (1) The reward to each supplier is determined through bargaining over the full revenue of the firm (as opposed to marginal contribution of the supplier), and (2) The reward structure combined with our sequential bargaining protocol gives rise to linkages across suppliers. The analysis in Antràs and Chor (Econometrica, 2013) identifies a mechanism in which upstream organizational decisions have spillover effects on downstream suppliers' investment incentives. Thanks to our novel features, we identify another mechanism: the spillover effects of downstream organizational decisions on the investment incentive of upstream suppliers. Next, we consider an open economy in which firms not only make organizational decisions but also determine where to source their inputs. We show that these decisions are connected between sequential production stages such that the sourcing location of the upstream input may affect the organizational choice in the downstream stage. We then examine how within sectoral heterogeneity and variations in industry characteristics influence the relative prevalence of firms that choose to form different organizational structures.