The International Organization of Production in the Regulatory Void

51 Pages Posted: 29 Oct 2019

See all articles by Philipp Herkenhoff

Philipp Herkenhoff

Johannes Gutenberg University Mainz

Sebastian Krautheim

University of Passau

Date Written: March 2019


Over the last decades, the internationalization of the value chain has allowed firms to exploit cross-country differences in environmental and labor regulation (and enforcement) in ways that have led to a large number of NGO campaigns and consumer boycotts criticizing ‘unethical’ practices. How do potential ‘unethical’ cost savings on the one hand and the threat to reputation and sales on the other interact with the international organization of production? In this paper we introduce North-South differences in regulation, a cost-saving ‘unethical’ technology and consumer boycotts into a standard property rights model of international production. Contracts are incomplete, so that a firm has limited control over both investments and (un)ethical technology choices of both foreign affiliates and suppliers along the value chain. We show that international outsourcing and ‘unethical’ production are linked through a novel unethical outsourcing incentive, for which we also provide empirical support: a high cost advantage of ‘unethical’ production in an industry and a low regulatory stringency in the supplier's country favor international outsourcing (as opposed to vertical FDI). We also provide a microfounded model of investment and pricing under incomplete contracts when the production technology is a credence characteristic of the final good and an NGO investigates firms and may initiate a consumer boycott.

Keywords: multinational firms, international outsourcing, property rights theory of the firm, ethical production, labor standards, pollution, consumer boycotts, credence goods, NGOs

JEL Classification: D210, D230, F120, F230, F610, J810, L220, L230, L310, L500, Q530

Suggested Citation

Herkenhoff, Philipp and Krautheim, Sebastian, The International Organization of Production in the Regulatory Void (March 2019). CESifo Working Paper Series No. 6922. Available at SSRN:

Philipp Herkenhoff

Johannes Gutenberg University Mainz ( email )

Saarstr. 21
Jakob Welder-Weg 4
Mainz, 55122

Sebastian Krautheim (Contact Author)

University of Passau ( email )

Faculty of Economics and Business Administration
Dr. Hans-Kapfinger-Straße 14b
Passau, 94032


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