An Agency Theory Investigation of Supply Risk Management

By Zsidisin, George A.; Ellram, Lisa M. | Journal of Supply Chain Management, Summer 2003 | Go to article overview
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An Agency Theory Investigation of Supply Risk Management

Zsidisin, George A., Ellram, Lisa M., Journal of Supply Chain Management


Every organization needs to acquire goods and services in order to carry out its mission and goals. Varying degrees of risk are associated with obtaining these inputs. An unplanned event may occur in their acquisition, delivery, and use that can negatively affect a firm's ability to serve its own customers. Supply risk is defined as the probability that such an event will occur and the resulting detrimental consequence on the purchasing firm.

Some degree of supply risk exists in every business organization. If contingency plans are not made to manage risk, the occurrence of a negative incident can have an immediate damaging effect on the purchasing firm. In order to understand how purchasing organizations address risk, this study creates and empirically tests a model of purchasing and supply management's involvement in supply risk management, using the agency theory perspective.

Organizations face numerous sources of risk with inbound supply. Risk can differ in type from supplier to supplier, in the duration of the risk, and in the degree of impact the good or service at risk has on the purchasing firm (Steele and Court 1996). Common methods employed to manage supply risk include inventory management (Lee and Billington 1993; Lee, Padmanabhan, and Whang 1997; Start and Miller 1962) and the use of multiple sources (Anupindi and Akella 1993; Newman 1989; Tullous and Utecht 1992). These techniques shield an organization from the effects of supply risk due to uncertainty by creating a "buffer" from the detrimental incidents that can occur.

In contrast to buffering the effects of risk, the purchasing organization may also attempt to reduce or eliminate the source of risk. Cyert and March (1963) asserted, "Firms will devise and negotiate an environment so as to eliminate the uncertainty." The researchers believe the goal of completely eliminating supply risk is unrealistic, but the goal of reducing the probability of a detrimental event is achievable. Therefore, supply risk management consists of purchasing organization efforts that reduce the probability of occurrence and/or the impact that detrimental supply events have on the firm. Because the context for managing supply risk involves a principal (purchasing organization) and agents (suppliers), an appropriate theoretical perspective for studying supply risk management is agency theory.


The following section establishes a theoretical foundation for studying supply risk management. This section begins with an introduction to agency theory. Next, a description of potential supply risk sources is presented. A discussion of behavior-based and buffer-oriented supply risk management methods follows. The literature review and theory development section concludes with hypotheses that will be tested.

Agency Theory

Agency theory is concerned with the study of problems that arise when one party, the principal, delegates work to another party, the agent (Eisenhardt 1989; Lassar and Kerr 1996). The unit of analysis is the metaphor of a contract between the agent and the principal. Previous studies employing agency theory as the theoretical framework have used "coordination efforts" (Celly and Frazier 1996), "control" (Anderson and Oliver 1987), and "management" (McMillan 1990) as the unit of analysis. In this research, the purchasing organization is the principal and the supplier is the agent. Variables that influence the contract between the principal and the agent include information systems, outcome uncertainty, risk aversion, goal conflict, programmability, outcome measures, and relationship length (Eisenhardt 1989). In examining supply risk, this study adopts the efforts of the purchasing organization to manage suppliers as the unit of analysis.

The management of risk can be categorized by outcome- and behavior-based contracts (Choi and Liker 1995; Eisenhardt 1989; Lassar and Kerr 1996).

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