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Hierarchies, Relational Contracts and New Forms of Outsourcing

We observe that economic restructuring is significantly changing organizational governance. On the one hand, we witness an increase in mergers & acquisitions, which substitutes markets for hierarchies and, on the other hand, we see an increase in outsourcing and subcontracting activities, appearing to replace hierarchies by markets. However, there is evidence that an increasing part of outsourcing activities mix hierarchies with market forms of governance. The key argument of this paper is that firms have established governance structures based on markets, hierarchies and self-enforcing relational contracts so that they are able to keep a substantial amount of control despite of sourcing out labour. Furthermore, we argue that such hierarchical forms of outsourcing produce dependency. Using empirical evidence of the Austrian insurance industry, it is demonstrated that dependency is created, firstly, by the contractual restriction of alternative uses of resources, secondly, by support measures that bind the upstream party closely to the downstream party, thirdly, by relationship-specific investments made by the upstream party, and fourthly, by authority elements.