THE EFFECTS OF FLEXIBILITY AND GOVERNANCE ON OUTSOURCING

Abstract

Outsourcing became an important corporate strategic issue and part of the business lexicon since the 1980s. Existing studies on outsourcing mostly focus on benefits of outsourcing such as cost saving and resource reallocation, and the results are generally ambiguous regarding outsourcing outcomes. We study three important aspects of outsourcing that were largely overlooked in the existing literature: the benefit of flexibility acquisition, the power play between the CEO and labor in outsourcing decisions, and the effects of flexibility and governance for global outsourcing. This dissertation consists of three essays and constitutes an empirical investigation that (a) what the effects of flexibility and governance are for US firms engaged in outsourcing, (b) how the power play between the CEO and labor affects the decision to outsource and its outcomes, and (c) how offshore outsourcing is decided and what the value of offshore outsourcing is. The first paper examines the influence of a firm's flexibility on its decision to outsource. It is commonly believed that flexibility is good, but there is little empirical evidence on whether flexibility affects corporate performance. The paper casts outsourcing in terms of real options and presents evidence regarding the value of flexibility for US firms engaged in outsourcing. From a real option perspective, a major source of gains from outsourcing is the flexibility it entails, compared to continued in-house production under high fixed cost and demand uncertainty. Empirical analyses include an examination of market reactions to outsourcing announcements and long-term post-outsourcing firm performance, as well as the relation between flexibility and outsourcing outcomes. The results show that market reactions are positive and significant, along with a potential synergy between outsourcing and insourcing firms. More importantly, after controlling for potential switching costs related to outsourcing, outsourcing gains are significantly associated with the presence of a firm's growth options. In addition, firm performance is related to corporate governance, underscoring the importance of effective corporate governance as a requisite to aid the realization of potential gains from outsourcing. The second paper asks the question of whether the power play between the CEO and labor affects a firm's outsourcing decisions and outcomes. Outsourcing can be viewed as a power play between the CEO and labor. Fundamentally, outsourcing may be potentially desirable because of cost saving and the value of flexibility. However, to make it happen, the CEO must negotiate with labor that may resist outsourcing because of its concern for jobs. Yet without outsourcing, the firm may lose out competitively and labor may lose even more. This paper empirically examines the extent to which outsourcing decisions and outcomes depend on CEO power and labor participation in major corporate decisions. Using the sample of US firms, we find that the likelihood of outsourcing is positively related to CEO power and negatively associated with labor power. More importantly, prior firm performance is likely to be a moderating factor in the resistance of labor against outsourcing. The long-term firm performance is found to be influenced by the power dynamics between the CEO and labor as well as the general efficacy of corporate governance. The third paper investigates the widely debated issue of offshore outsourcing. Given the diversity of cost structure, the gains from outsourcing can be potentially greater internationally than domestically. While uncertainties are greater internationally, these may be offset by the real option benefits of a multinational network. Empirical work for U.S. outsourcing firms indicates that the market valuation is greater and more significant for international outsourcing than domestic outsourcing. The gains are related to flexibility that can be obtained from multinational network. In addition, international differences in locational factors including differences in corporate governance influence the valuation gains from outsourcing as well as the division between outsourcers and insourcers.