Abstract

Outsourcing contract with IT asset transfer limits the options of the client firm in vendor selection in future, and it is puzzling as why client self creates “switching costs” which limit her own contractual options. This paper attempts to unravel this puzzle through a game theoretic set up wherein the client faces vendors endowed with heterogeneous capabilities whose effort is unobservable and though IT services quality is observable; it is not verifiable and thus not contractible. Counter to intuition, we show that client uses asset transfer as a costly device to screen out vendors of low capability and voluntarily lock herself in a long-term relationship by enhancing the bargaining of the vendor ex-post. We extend the model to a multi-tasking vendor who also exerts asset-upgrading effort and show that screening power of IT asset transfer in enhanced when asset-improving effort has spill over effect on delivered IT services.

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