Optimal Software Outsourcing Contract under Asymmetric Information: Bundling Development and Maintenance Support

Recent research has called for studying optimal outsourcing contracts when some aspect of the quality of software is observed but is not verifiable. In this paper we model a software application outsourcing relationship wherein a client offers contracts for development of application software and providing maintenance support over a period of time. Quality of delivered software is impacted by intrinsic efficiency and effort, but is not contractible. We show that the client uses a development and support bundling contract as a screening device and second-best efficiency is achieved under certain conditions even in the presence of adverse selection. Counter to intuition, we find that the client may induce a shorter maintenance support period for a higher quality software application. Surprisingly, under information asymmetry and verifiable quality, unbundling contracts may enable the client to induce higher quality and longer support period.