The Use of Management Control Mechanisms to Mitigate Moral Hazard in the Decision to Outsource

Journal of Accounting Research, Forthcoming

Posted: 13 Jan 2012

See all articles by Karen Sedatole

Karen Sedatole

Goizueta Business School

Dimitris Vrettos

affiliation not provided to SSRN

Sally K. Widener

Clemson University

Date Written: January 12, 2012

Abstract

Using archival data from the U.S. passenger airline industry, this study examines whether management control mechanisms aimed at mitigating moral hazard explain outsourcing decisions over and above transaction cost economics (TCE) determinants documented in prior research. Consistent with TCE theory, we find that in-house production efficiencies and our proxy for transaction risk (i.e., deriving from transaction infrequency, transaction complexity, and relationship specific investments) significantly explain the extent of outsourcing of aircraft maintenance. We extend TCE insights to show that incentive delta (i.e., the sensitivity of CEO portfolio holdings to stock price changes) strengthens the negative association between production efficiencies and outsourcing while incentive vega (i.e., the sensitivity of CEO holdings to stock return volatility) weakens the negative association between transaction risk and outsourcing. Monitoring strengthens the negative association between in-house production efficiencies and outsourcing, but has no effect on the transaction risk-outsourcing relation. The results suggest that the use of outsourcing to achieve cost savings is promoted through both incentive contracts and monitoring, but outsourcing to achieve the desired risk level is promoted only through incentive contracts.

Keywords: Managerial risk aversion, Stock options, Risk-taking incentives, Monitoring, CEO Compensation, Transaction costs, Outsourcing, Management Control

JEL Classification: D23, J33, M2, M4, M52, M55

Suggested Citation

Sedatole, Karen and Vrettos, Dimitris and Widener, Sally K., The Use of Management Control Mechanisms to Mitigate Moral Hazard in the Decision to Outsource (January 12, 2012). Journal of Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1984340

Karen Sedatole (Contact Author)

Goizueta Business School ( email )

1300 Clifton Road
Atlanta, GA 30322-2722
United States

Dimitris Vrettos

affiliation not provided to SSRN

Sally K. Widener

Clemson University ( email )

Clemson, SC 29634
United States

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