Risk Management and Intellectual Property Protection in Outsourcing

Abstract

Firms organize business activities either in-house or outsource them to independent service providers. When making their organizational choice, firms face a trade-off between efficiency and loss of intellectual property (IP) when outsourcing. It is found that companies may gain from outsourcing even if there is possibility of IP misappropriation and moral hazard due to shirking. It is recommended that firms use a variable payment scheme linked to project outcome that would incentivize service providers to exert optimal effort in outsourcing projects. Moreover, when a task is outsourced in a weak IP regime, the optimal contract must implement a carrot and stick strategy comprising of limited IP sharing in conjunction with adequate incentive payments to the service provider.