Equilibrium strategy for human resource management with limited effort: in-house versus outsourcing

When outsourcing human resource activities to a vendor, a firm with limited effort may want to save energy to focus on core competencies. However, the firm could also lose control over these activities by outsourcing, especially in a situation with unobservable action, and this could in turn increase cost. In this paper, we consider a firm with limited effort performing core and non-core human resource activities and aiming to choose an appropriate human resource management strategy, in-house or outsourcing within a framework of agency theory. We show that only when the effort ceiling is low enough, will the firm completely commit to its core activities. Surprisingly, under outsourcing strategy with double moral hazard, we find that both of the vendor and the firm distort their efforts. Moreover, the outsourcing strategy is optimal if the effort ceiling is low enough or if the cost of the non-core activities is high and the positive interaction between the two activities is low. Otherwise, the firm prefers the in-house strategy, especially in the case with a high effort ceiling and unobservable action. In addition, we also find that a high revenue generation capacity for the core activities may increase the motivation of the firm for outsourcing.