Information asymmetry and dynamic sourcing: Evidence from Chinese firms

Abstract

AbstractInformation asymmetry can create substantial frictions when importing firms find it difficult to acquire information about foreign products. I use detailed China Customs Data to show that firms tend to import from countries with which they already have an importing relationship. This preference cannot be sorely explained by the sunk cost, and it still exists even if the firm, country, sector and year‐related fixed effects are controlled. Motivated by these facts, I develop a dynamic model describing firms' decisions on their choice of sourcing country. This model incorporates both communication cost and satisfaction uncertainty, which are lower for familiar countries than for unfamiliar ones. By using this model, I estimate the benefits of importing from familiar countries measured by the probability improvement of receiving satisfactory products. I find that this probability can be improved by a maximum of 89.0% when importing from familiar countries instead of from unfamiliar ones. These results also support the prediction that the effective unit cost of intermediates is lower when importing from familiar countries.