Incomplete contracts and the make or buy decision: Governance design and attainable flexibility

A common recommendation by management advisors is for organizations to adopt procedures which facilitate the forming of close cooperative working relationships with subcontractors. A central theme of this research is to explore why such issues are being emphasized at this time and then to indicate how accounting systems can give rise to powerful countervailing incentives which stifle attempts to work cooperatively. In order to address this problem it is proposed that modification be made to the orthodox computational philosophy, embedded in the traditional accounting make or buy decision calculus. To illustrate the basis for the modification argument, a review of Japanese subcontracting practices is presented. Such practices have relevance since the recent Japanese manufacturing preeminence, can in part, be attributed to the institution of effective motivational and control structures for subcontractors. A discussion is presented of how these structures promote rapid flexible technological transfer and sharing between a network of subcontractors and an assembler. The incentives associated with these governance structures are shown to differ markedly from those under traditional make or buy procedures. In the process of developing modification proposals, it is shown that if an assembler is to gain from increased flexibility in the production relationship with a subcontractor this simultaneously requires reduced flexibility in choice over forming competing relationships. Thus it is argued that a search for possibilities of increased overall flexibility needs to be understood within a more naunced comparative sense. This in turn gives rise to important new implications for the focus of accounting calculus. Moreover it is argued that borders between the practices of control and of consultative guidance become less clear, which in rum also has implications for the focus. Copyright (C) 1996 Elsevier science Ltd