Agency Theory in Supply Chain Management
The agency theory has been around for quite a long time, but formalization of theory dates back into the 70s. In the past, there have been researches done on this topic such as the one done by Rechner and Dalton (1989) to examine the effect of management duality on risk and its effects to the share price. Others include but not limited to (Grover and Malhotra, 2003; Slack et al, 2004; Mabert and Venkataramanan, 1998; Pannirselvam et al, 1999; Selen and Soliman, 2002). In supply management, the agency theory implies that the retail chain is a series of agreements between shareholders. This agency relationship arises when groups of owners, known as the principals, hire another group, called agents for the day-to-day operations of a supply outlet some services are delegated to the new decision-making authority. Agency relationships in supply chain management are those between suppliers and management and between buyers and suppliers (Ketchen & Giunipero, 2004).
In order to make the relationships harmonious a clear agreement informs of a contract is put in place. However, conflicts are a common occurrence in agreements of this nature. Actually, agency theory concentrates with agency conflicts, which are conflicts of interest among the different interested parties. The effects of these conflicts among other things include corporate governance, code of conduct, conflict resolution processes and ethics. There are costs for the operation of agencies, which is the expenditure in order to maintain a successful agency relationship. Some of this cost include but not limited to costs incurred when giving management performance bonuses for motivational purposes to managers. The agents are supposed to always act to the best interests of the shareholders in business. However, the managers will only act accordingly when proper governance structures and corporate obligations are met (Fama & Jensen, 1976). This paper seeks to show the application and importance of the agency theory within the supply chain management and more importantly, the theory can be implemented in such cases. The paper further explains means of evading conflicts in such agreements, which can be incorporated dulling implementation.
Supply chain management is recognized a fundamental aspect for any demand based distribution however, existing reports of this operation management theory in supply chains tends to be specific and usually focus on one company in its distribution systems. By adopting a multi-sided aspect of research where the buyer and supplier relationship are well addressed then it will be possible to empirically. Further theory testing centrally to theory building will eliminate the reluctance to apply and integrate agency theory into the successfully running a distribution system. By concentrating on functions rather than theoretical practices at the industry level, rather just the supply chain level then it will be possible to draw better and more specific conclusions through of analysis.
An assumption that supply chains are only demand driven is not comprehensive. With these in mind then a more comprehensive study on supply chain application of the agency theory needs to be carried out. The analysis must include all the supply chain links such as the final customer or consumers who are significant determinants of sales (Ketchen & Giunipero, 2004). Some of the products that have been successfully distributed to the end user through the agency method include fast moving consumer goods, computer assembling and accessories, automobile assembling and many other goods in the market (Burgess et al2006).
Importance of the Agency Theory
The agency theory has been identified by many companies as the most efficient means of expanding at minimal costs. Thorough predictions and explanations done by professionals on different organizations led to the selection of this theory. Institutional arrangements, which range from the sale on the spot market to those within the organization, are significant when analyzing and determining a supply chain management model. By critically observing which transactions can be classified as determinants of operations due to their frequency occurrence, then a supporting theory testing should be conducted. The level of uncertainty also can be used to in the due process. The nature of transactions themselves can be used to identify a solution to optimize operations. Human behavior is also an aspect to be considered since it influences the costs of transactions as well as their frequency this is further elaborated by Williamson (1991) where he explains more on rationality, cognitive assumptions, and behavioral assumptions. In analyzing the problems associated with human behavior, firms are driven by self-interest. This is unique to the different parties in the agreement where agents are considered most opportunistic.
Since the principal hires and retains the agent because of their specific talents, knowledge and capabilities then a supply chain that adopts the theory is bound to rip benefits in terms of to increased sales and rise in stock prices due to trust that the public has on such arrangements. The theory further assumes that the interest of owners is aligned with those of the management so that continuous increase the value of that entity can be realized. Some of the principal’s decision rights over that entity in this case are transfer to the agents and more enactment of ratifications, sanctions and monitoring mechanisms. This guards the shareholders against failure of managerial competence or failure of managerial integrity. Mistakes or misconception of a supply chain due to any of the two is the agent’s full responsibility. Further, agency theorists suggest means of solving inefficiencies imposed on the supply chains by the triple veil. By aligning decision, rights with the specific knowledge required to competently exercise them.
The agency theory provides a structure, which can model and understand a variety of human arrangements and agreements where incentive Compensation, auditing, and bonding arrangements of all kinds are well expounded. General knowledge from the principle imply that decision rights be pushed downward in the supply chain hierarchy. The agency theory devises structural and behavioral mechanisms that ensure accountability and motivation at the same time through the contracts entered between the principal and agents. The hiring of agents helps the supply chain to attract other sources of intellectual, social and human capital to the organization, these occurs when firms and individuals who are not associated with the firm in itself, will want to contribute in one way or another via the agents.
Implementation of the Agency Theory in Supply Chain Management
The distinguishing characteristic of the theory is to separate of ownership of the supply chain of a firm from control of the supply chain. The ownership of the chain is still in the shareholders of the firm; control over the day-to-day operations is in the hands of professional managers herein defined as the agents. The agents take actions whose consequences are largely carried by the owners of the firm. Shareholders put in place ratification, monitoring and sanctioning in the form of compensation and chastisement measures (Fama and Jensen, 1983). Ratification measures are those put in place to validate the decisions made by the agent. Approval might be needed when certain changes are being implemented. This can be done in the form action plan approvals by the principals.
Monitoring measures are for continuously assessing, recording and measuring the output and efficiency of the of the agents efforts. Sanctioning measures provide selective rewards and punishments to agents for the reason of empowering and encouraging them to focus on the directions that is of interest to the owners. There are two broad models of supply chain management. These are the centralized decision-making and the decentralized decision-making. The agency theory focuses on the decentralized supply chain with the benefit of more efficient cooperation and coordination. Though currently majority of applications of agency theory focuses on the study of risk within the supply chain steps towards adopting it in corporate governance. This is in contrast with stock’s (1997) suggestion on the use of agency theory to investigate inter-organizational relationships in logistics and supply chain system. As a result, the agency theory can be used in developing governance mechanisms and elasticity in buyer and supplier relationships.
In the past, the supply chain managements applying the theory either formally or otherwise have had occasions where the agents had conflicting goals. This calls for measures and mechanisms such as governance mechanisms that limit the agent’s self-centered goals. The role of the agents as the organizers and controllers is detrimental to the shareholders if such measures are not taken. However, the positivity theoretical point of view the greatest concern is a description of the systematic implementation and solving the leading agency problem. The assumption of self-interest between the two parties in the contract may result into selfless behavior and the self-interest only decreases when there is trust between them. Risk-sharing considerations should be made based on the assumption of risk adverse agent. As such, it can be stated that for supply chain, the self-interest in each party is negatively related to the behavior-based arrangements and positively related to contractual agreements.
The basic elements of the theory in supply chain
The theory can be used to determine the exact rewards and incentives that the agents are entitled to. However, this can be easily elaborated in four principal elements, which include the production process, the terms of the contract, the benefit of each party and the timing of events. The production process involves the agent’s total contribution to the organization and most importantly the external forces and actions of the agents. In supply chain management, the efficiency of the implemented policies by the agent depends on the extent of their efforts to the output of the firm (Rechner & Dalton, 1989). Depending on what is indicated in the contract supply, chain management applies linear contracts where analysis is easy and there is equity in incentives if otherwise unintended discouragement may occur or even demoralization. Stock options are considered a form of uniform incentive. However, when the incentive is in the form of money it ends up being flat below and linear on the high. Although money incentives have the advantage of adding purchasing power, which is valued by many people, it is not easy to achieve this concept.
The conservation of value principle plays a significant role in uniting, empowering and motivating both parties. As a result, they minimize the cost of entering into contractual terms, which would otherwise call for continuous monitoring, and assessments as well as enforce the contracts perfectly. The fact that there is uncertainty in the supply chain measures should be put to deal with bankruptcy or other negative outcomes. External forces such as government regulations, competition and industrial revolutions through innovations may significantly affect the outcome of the supply chain.
The theory gives a room for ramifications of outcomes during such uncertainties. During such processes, the common method is to identify a policy where the interest of both parties diverge and then go ahead and demonstrate that by aligning agents behaviors with the interests of the owner the agency problem can be solved. In situations such as acquisitions, mergers, divestitures and hostile takeovers mitigation processes are necessary to solve the agency problems. Although resistance to takeovers by agents may not be to the best interest of the shareholders it is to their interest since this might mean loss of their positions and action has to be taken.
Behavior based contracts are used where there is difficulty measuring the outcomes of the firm but they do not apply a lot in the supply chain because outcomes can easily be determined through sales and revenues against the set target. The agency theory should be recommended for supply chain management since the situational aspects that determine theoretical domains seem to favor the theory. The fact that the theory has been successfully used to maximize the performance of a supply chain while still maximizing the shareholders returns shows its capability.
From the foregoing is important to any organization dealing with supply chain because it provides opportunities on how risks can be avoided. It also provides an avenue where the threat of opportunism can be minimized along any supply chain. The organization can be able to do this by using some incentives that ensure that goals are adequately achieved. Further to this, it is important for all organizations to put this theory into practice because it is useful in monitoring all the activities taking place along a supply chain. By so doing, an organization can be able to minimize costs thereby increasing the profitability and revenue earnings.
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