Choosing between Foreign Direct Investment and International Subcontracting. A Model of a Multinational Firm's Decision in a Context of Moral Hazard

The present paper develops a moral hazard model applied to a multinational firm (MNF)'s decision between foreign direct investment (FDI) and international subcontracting. We compare the results of the moral hazard model, characterized by the fact that the MNF is not able to control operations performed by the subcontractor firm, with the traditional model, which considers symmetric information. We conclude that the uncertainty associated with the subcontractor firm's behaviour, in spite of increasing the preference of the MNF to engage in FDI, does not change the optimal decision, which continues to be to subcontract. The exception occurs in the case that the subsidiary stands as more efficient than the subcontractor firm.