Management of principal-agent problems in supply chains.

• Author: Winkler, Herwig
• Position: Report

1. PROBLEM DESCRIPTION

   The implementation of supply chain management occurs in everyday business mostly through the creation of cooperations and networks of certain enterprises in a supply chain. The initiator of supply chain management projects is often a focal enterprise. This enterprise selects the partners needed for the creation of a supply chain network. Due to its position of power, the focal enterprise very strongly influences both the 'supply side' and 'demand side' of the supply chain network. In order for the supply chain management to succeed, and to develop and operate effective supply chain networks, the focal enterprise needs to conduct comprehensive analyses of existing and potential principal-agent problems (Compte and Jehiel, 2008). The findings of principal-agent theory are very useful to have when it comes to behavioral control measures and creating contracts. Due to the great importance found in inter-organizational management concepts, e.g. in supply chain management, it's helpful to investigate principal-agent problems in business relations between different companies. For a lasting, successful achievement of supply chain management, it's therefore of great necessity to investigate potential problems that may occur between the principal and agent within the existing business relations (Kiener, 1990; Mannel, 1996; Picot et al., 2001) in order to obtain important findings for the creation of the cooperation in the planned supply chain network (Lambert and Cooper, 2000).

2. FOUNDATIONS OF SUPPLY CHAIN MANAGEMENT AND PRINCIPAL-AGENT THEORY

   2.1 Supply chain management in the formation and operation of supply chain networks

   The literature attributes to supply chain management (SCM) the strategic and operative planning, organization, management, and coordination of the entire company material and service flows and/or value-added process (Cox, 1999), including the related information and monetary flows (Pfohl, 2000; Hahn, 2000; Schonsleben, 2007). Conducting supply chain management involves fulfilling the two main tasks of creating and managing the supply chain. The goal of creation is forming competitive structures in the supply chain by setting up supply chain networks. The management fields frequently include the members, potential/resources, processes, as well as the products of the supply chain network members. SCM pursues the fundamental goal of increasing the effectiveness and efficiency of the creation of goods and services in the supply chain. This means avoiding all waste according to 'lean thinking' and achieving a high level of customer orientation. Borrowing from the value chain by Porter, a 'supply chain-wide' value chain needs to be created and optimized. When deciding upon the formation of goods and material flows, the effects upon the entire supply service of all suppliers as well as the delivery service of the end user need to be considered. In addition, decision interdependencies must be heeded to ensure an optimization of the services of the entire strategic supply chain network. Figure 1 shows the companies and business relations of a supply chain network.

   [FIGURE 1 OMITTED]

   The goal of steering the supply chain is optimizing the use of resources in the participating companies and successfully handling the interfaces between the involved partners. Acquisition-, production-, and distribution volumes need to be coordinated, managed, and optimized while taking into account the goals of cost, quality, flexibility, and time (Hines, 2000). Depending on consumer demand, the creation of goods and services has to be collaboratively planned and achieved (Hahn, 2000). Doing this achieves a better customer orientation; a synchronization of supply and demand; inventory reduction along the value-added chain; as well as a flexible production that is consistent with demand (Schonsleben, 2007).

   2.2 Main features of principal agent theory

   In the economic sciences, principal-agent problems are discussed in connection with management problems that arise with certain contract relations. Principal-agent relationships are characterized by a principal and an agent who interact within an environment characterized by imperfect information and uncertainty (Elschen, 1991; Mensch, 1999). The principal-agent theory assumes that the agent has certain tasks to fulfill for the principal. In accomplishing them, the agent freely accesses certain means, instruments, and resources. However, the principal expects that the task be fulfilled in accordance with his interests. When this is the case, conflicts of objective often arise between the principal and agent. Both parties seek the maximum benefit for themselves that involves three aspects (Ebers and Gotsch, 1995). First, the conduct is based upon given, stabile preferences. Second, the maximization of benefits is oriented towards the individual advantage of the actors. Third, opportunistic practices such as the use of deceit and fraud are possible. The utility function of the agent always includes a wide spectrum of goals, which include everything from monetary goals such as wages and premiums, all the way to intangibles such as career building, power, and prestige (Mukherji et al., 2007). Self-serving behavior on the part of the agent is done at the expense of the principal. But this behavior is only possible because the principal is not sufficiently informed about the agent and his conduct.

   There is thus an information asymmetry between the principal and agent that the agent often exploits to his own maximum benefit (Mensch, 1999). Here, three different forms of information asymmetries can be discerned, where each form is characterized by its own information advantage for the agent. In addition, a specific form of behavioral uncertainty is also involved. With information asymmetries, a distinction must be made between hidden characteristics, hidden action/hidden information, and hidden intentions. From these result the behavioral uncertainties of adverse selection, moral hazard, and hold up (Spremann, 1990; Breid, 1995; Dietl, 1993). Figure 2 presents the different information asymmetries and their resulting behavioral uncertainties.

   [FIGURE 2 OMITTED]

   The goal of the principal-agent theory is analyzing the problems occurring due to behavioral uncertainty, and developing suggestions for solutions to these problems. This includes e.g. the contract formation for the fulfillment of the principal's requirements. In addition, performance incentives and monitoring systems that help keep an eye on the agent are also discussed (Picot et al., 2001). Here, a difference must be made between process-oriented and result-oriented incentive and monitoring systems. With process-oriented incentive systems, the conduct of the actors is influenced, i.e. measures that steer behavior are applied. Keeping an eye on behavior is part of a process-oriented management system. A difference must be made here between result-oriented monitoring-and incentive systems. This attempts to improve results via incentives and/or monitoring. The result is therefore the focal point of the following discussion.

3. ORGANIZATIONAL THEORETICAL STUDY OF SUPPLY CHAIN NETWORKS AND

   PRACTICAL EXAMPLES OF PRINCIPAL-AGENT PROBLEMS

   3.1 The creation of strategic supply chain networks from the viewpoint of organizational theory

   For the investigation of principal-agent problems in the creation of supply chain networks, it is necessary to give a quick summary of the organizational characteristics of supply chain networks. From the organizational characteristics, the relationship-specific features between the focal enterprise and its partners can be derived. According to the universal definition, an organization is "a unit of organized parts that are connected to each other." (Hoffmann, 1980, p. 1426). This characteristic is well-fulfilled by strategic supply chain networks, because different companies (ideally) work together from the initial production of raw material all the way to the end customer to achieve one or more goods/services. Because the focal enterprise must coordinate the overall company activities, it can be assumed that strategic supply chain networks establish well-ordered, well- defined connections and interfaces among the different companies within them. With supply chains that are very long, it can however be assumed that this structure is only of importance within a limited realm and, due to the multifaceted company relations, a large complexity prevails. Of even greater significance for the investigation of principal-agent relationships is that supply chain networks have to be seen from an institutional standpoint as a goal-oriented social system that contains an identifiable circle of members, a collective identity, an internal differentiation of roles, a distribution of power, a delegating of responsibility, an internal stability, the opportunity for membership substitution, and an intended rational approach to achieving goals. The creation of strategic supply chain networks does not produce a new, homogenous social system. Instead, a heterogeneous system results from the combination of the individual company systems. When viewed from a functional perspective, strategic supply chain networks are supersystems that are differentiated into work- specific subsystems and integrated by focal enterprises into a goal-oriented entirety (Hentze and Brose, 1985; Bleicher and Meyer, 1976). With the help of strategic supply chain networks, a functional organizational form has to be created with which the cooperation between those who are producing goods and services and those who are selling them to the consumer can be successfully executed. The functional and institutional viewpoints of supply chain networks therefore represent particularly important guidelines for supply chain management activities. The various companies in the supply chain need to be selected, evaluated, and assigned...