Firm Boundaries and Knowledge: the Lobbyists' Case.

Abstract: Despite the growing relevance of knowledge-intensive industries, there is not a comprehensive study explaining firms' decisions to contract in and out service providers when the knowledge is the key input in the production process. The fundamental trade-off I propose to study firm's decisions is as follows: Outsourcing brings high levels of knowledge to the firm at the cost of transmitting industry-specific knowledge. On the other hand, by hiring someone internally, the agents save these communication costs, with the downside of incurring learning costs. Given this trade-off, firms hire someone in-house to deal with the most frequent problems they face, and they hire an external provider to solve the less common problems. Using data on Federal lobbying reports in the US, I find support for these and other predictions of the theory. Concretely, I find that the probability of integration is increasing in the frequency of the transactions, the industry-specific knowledge and the easiness of the tasks. Using exogenous variation in the difficulty of lobbying activities provided by the BP oil spill case of 2010, I find causal evidence of the main predictions of my model.