Organizational Constraints and Outsourcing under Demand Uncertainty: Evidence from the Brazilian Electricity Distribution Industry

Abstract

This paper examines how public firms’ organizational constraints affect the sensitivity of labor outsourcing to demand uncertainty. We focus on a single industry in which state-owned firms are subject to additional organizational constraints that private firms are not. We mitigate omitted variable bias by considering the endogenous trade-off between insourcing and outsourcing by measuring average labor prices for each firm. We find that, on average, private firms with strong incentives for profit and flexibility rely more on outsourcing; moreover, their outsourcing is more sensitive to relative prices of insourced and outsourced labor. However, when demand uncertainty arises, state-owned firms increase outsourcing more, making their outsourcing less sensitive to input prices. The results suggest the organizational constraints of state-owned firms, such as multiple objectives other than profit maximization and strong labor protection of insourced labor, exacerbate the downside risk of hiring insourced labor under fluctuating demand, leading state-owned firms to rely more on outsourcing.

Keywords: outsourcing, cost behavior, demand uncertainty, organizational constraints