Relational Contracts and Global Sourcing

Abstract

Relational contracts – informal agreements sustained by the value of future relationships – are integral parts of global production processes. This paper develops a repeated-game model of global sourcing in which final goods producers decide whether to engage with their suppliers in relational contracting and whether to integrate a supplier into a firm’s boundaries or deal with the latter at arm’s length. The model predicts that the likelihood of vertical integration increases in the long-term orientation of cooperation parties. Combining data from the U.S. Census Bureau’s Related Party Trade database with measures for long-term orientation from Hofstede et al. (2010) and World Values Survey, I find empirical evidence supportive of this paper’s key prediction. To better understand if the relationship is causal, I apply instrumental variables approach using genetic proxies and inherited components of long-term orientation as instruments. Taken together, the evidence suggests that the level of long-term orientation of the home and host country has a positive effect on the relative prevalence of vertical integration.