Richard E. Saouma

Optimal Second-Stage Outsourcing

Manufacturers have recently begun outsourcing product assembly and completion tasks to their suppliers. Such outsourcing solves several contracting problems but generates new incentive frictions between manufacturers and their suppliers. In this paper, we analyze a manufacturers decision to outsource an assembly (second-stage) task to a preestablished supplier. We find that outsourcing second-stage tasks becomes more attractive as the cost of either the first-or second-stage activity rises. Outsourcing becomes less attractive when the supplier is unable to accept large levels of liability. The manufacturer is shown to prefer more testing when she outsources assembly to her supplier as opposed to when she assembles products in house. Last, we find that the contracting frictions identified persist when the suppliers work can be tested individually, albeit imperfectly.

Resource Allocation Auctions within Firms

There is growing interest in the use of markets within firms. Proponents have noted that markets are a simple and efficient mechanism for allocating resources in economies in which information is dispersed. In contrast to the use of markets in the broader economy, the efficiency of an internal market is determined in large part by the endogenous contractual incentives provided to the participating, privately informed agents. In this paper, we study the optimal design of managerial incentives when resources are allocated by an internal auction market, as well as the efficiency of the resulting resource allocations. We show that the internal auction market can achieve first-best resource allocations and decisions, but only at an excessive cost in compensation payments. We then identify conditions under which the internal auction market and associated optimal incentive contracts achieve the benchmark second-best outcome as determined using a direct revelation mechanism. The advantage of the auction is that it is easier to implement than the direct revelation mechanism. When the internal auction mechanism is unable to achieve second-best, we characterize the factors that determine the magnitude of the shortfall. Overall, our results speak to the robust performance of relatively simple market mechanisms and associated incentive systems in resolving resource allocation problems within firms.

Multistage Capital Budgeting with Delayed Consumption of Slack

Capital budgeting frequently involves multiple stages at which firms can continue or abandon ongoing projects. In this paper, we study a project requiring two stages of investment. Failure to fund Stage 1 of the investment precludes investment in Stage 2, whereas failure to fund Stage 2 results in early termination. In contrast to the existing literature, we assume that the firm can limit the managers informational rents with the early termination of the project. In this setting, we find that the firm optimally commits to a capital allocation scheme whereby it forgoes positive net present value NPV projects at Stage 1 capital rationing, whereas at Stage 2, depending on the managers previous report, it sometimes implements projects with a negative continuation NPV but in other situations forgoes implementing projects with positive continuation NPVs. This paper was accepted by Mary Barth, accounting.

The Incentive Value of Inventory and Cross-training in Modern Manufacturing

ABSTRACT This paper shows that major components of modern manufacturing processes, such as inventory management and cross-training, play a significant control role. In our model, workers possess information that is critical to efficient ongoing operations. An organizational design that motivates workers to optimally apply this information leverages both the production schedule and worker-management communication. Managements use of these controls results in work-in-process (WIP) inventory that appears excessive from a pure job-scheduling perspective, but is optimal when control issues are considered. Empirical work testing pure job-scheduling theories of modern manufacturing practices has yielded mixed results. We provide control-related interpretations for these empirical findings, and also provide novel predictions regarding the link between inventory levels and the nature of operational information asymmetries. Overall, our model highlights the importance of recognizing both control and scheduling issues when analyzing production processes. Copyright (c), University of Chicago on behalf of the Accounting Research Center, 2009.