Controlling for supplier switching in the presence of real options and asymmetric information

Applying a real option approach, this paper examines how asymmetric information alters key variables of a firm’s supplier switching process, such as the timing of contracting (hurried versus delayed contracting), transfer payments, set-up, switching, and abandonment decisions. In a symmetric information setting, delayed contracting is unambiguously beneficial. Abandoning the once established relation with the entrant supplier is never an issue. In contrast, under asymmetric information hurried contracting with potentially abandoning the relation can be beneficial. Consistent with adverse selection models, we find that under delayed contracting, in equilibrium, the firm switches less frequently to the entrant supplier (switching inertia). Surprisingly, we also find that under hurried contracting the firm switches more frequently to the entrant supplier (switching acceleration) and may abandon the relation. Finally, we study how these key variables of the supplier switching process change when also the incumbent supplier has private information (two-sided asymmetric information case).