Cui Bono Cui Malo? Contractual Complementarity for Rent Appropriation in Strategic Outsourcing

Abstract

With the rise of strategic outsourcing, the distribution of skills and competences between partners grows increasingly uneven.This misalignment reflects the complex distribution of responsibilities under outsourcing arrangements.Because each firm in an outsourcing arrangement may have to surrender some control over tasks and processes performed by its partner, agency problems may arise on both sides.To resolve this tension, partnering firms design incentive contracts that include liability sharing instruments to align efforts and mitigate risk in the event of litigation. Although liabilities are generally negotiated simultaneously with provisions to share future revenues from outsourcing, the outsourcing literature reveals little about the complementarity of such instruments and their overall effect on value distribution.To address this lacuna, we develop a theoretical model and a set of simulations, which we test on a sample of R&D outsourcing agreements from the pharmaceutical industry. In our framework, complementarity among royalties, bonus payments, and liability clauses determines configurations of contractual instruments that apportion rents and allocate future liability costs.We find also that two boundary conditions can affect the outsourcing relationship, bargaining power and each party’s relative knowledge.