To lohn or not to lohn---a puzzle in subcontracting arrangements: Theory and evidence

The dramatic increase in outsourcing has led to a burgeoning theoretical literature that tries to explain the associated organization of production. So far, however, the literature has focused solely on analyzing the determinants of decisions by outsourcing firms, but has ignored the firms to which production is outsourced. This dissertation bridges this gap in the literature by studying outsourcing decisions not from the point of view of the outsourcing firm alone, but as a joint process that actively involves the manufacturer to which production is outsourced.;In the theoretical part of the dissertation we focus on a particular form of international outsourcing, also known as the lohn system, in which the outsourcing firm provides the manufacturer with all the inputs needed to produce and then re-imports the final goods. We use an incomplete contracts framework to show that the lohn system is more likely to be adopted the lower the manufacturer's ability to find low-cost inputs; the lower the bargaining power of the manufacturer; and the lower the degree of relationship-specificity.;In the empirical part of the dissertation we test the above predictions of the model. We exploit two unique firm-level databases from the National Institute of Statistics in Romania that provide information on physical production and balance sheet items for a large number of firms in Romania, collected monthly for the years 2005 and 2006. We use the data sources to construct two different datasets, one at the firm level and the other one at the firm-product level. We present firm-level results for cross-sections for the years 2005 and 2006, while at the firm-product-level we provide results for both cross-section and panel data.;Our empirical findings support the main predictions of the theoretical model. For instance, measuring the bargaining power of the manufacturer as the ratio of domestic to export sales, we obtain that the lower this ratio is, the more likely it is that the manufacturer will adopt the lohn system. Similarly, consistent with our theoretical model, we find that the lower the firm or product specificity, the higher the likelihood of adoption and the extent of usage of the lohn system. Using firm age as a measure of its ability to obtain the low-cost input provides mixed evidence for our theoretical prediction. Our results are robust to the use of different estimation procedures, measures, and samples.