Accounting for ambiguity and trust in partial outsourcing: A behavioral real options perspective

Abstract

Concerned with the hidden costs of outsourcing, this paper examines the role of ambiguity and trust in partial outsourcing decisions from the perspective of real options theory. We study pricing and quantity dynamics between an ambiguity averse vendor and a less (more) trusting client in a leader-follower framework with fixed timing. We find that a client's partial outsourcing quantity increases with the vendor's ambiguity if outsourcing is meant for cost-saving purposes. Meanwhile, the effect of trust on outsourcing quantity is jointly moderated by the vendor's ambiguity and quality of shared information forecasts when cost advantages are exaggerated. In terms of pricing effects, the vendor increases (decreases) their threshold with increasing ambiguity for long-term (short-term) contracts. These insights hold under the multiple-priors and worst-case ambiguity specification. When Choquet ambiguity and rank-dependent utility are considered, more complex and subtle dynamics are obtained. Ambiguity has additional non-linear effects on outsourcing quantity due to heterogeneity in ambiguity preferences (seeking versus aversion) and probability weighting. The vendor's price not only increases (decreases) with increasing ambiguity-seeking for long-term (short-term) contracts, but also with ambiguity aversion when specific risk-return conditions are met. Trust effects are qualitatively similar under both ambiguity specifications.