Shareholder value implications of service failures in triads: The case of customer information security breaches
| Date | 01 May 2015 |
| Author | Michael A. Wiles,Sachin B. Modi,Saurabh Mishra |
| Published date | 01 May 2015 |
| DOI | http://doi.org/10.1016/j.jom.2014.10.003 |
Journal
of
Operations
Management
35
(2015)
21–39
Contents
lists
available
at
ScienceDirect
Journal
of
Operations
Management
j
o
ur
na
l
ho
mepage:
www.elsevier.com/locate
/jom
Shareholder
value
implications
of
service
failures
in
triads:
The
case
of
customer
information
security
breaches
Sachin
B.
Modia,∗,
Michael
A.
Wilesb,1,
Saurabh
Mishrac,2
aCollege
of
Business
and
Innovation,
University
of
Toledo,
2801
West
Bancroft
St.,
Toledo,
OH
43606,
United
States
bW.
P.
Carey
School
of
Business,
Arizona
State
University,
400
E.
Lemon
St.,
Tempe,
AZ
85287,
United
States
cDesautels
Faculty
of
Management,
McGill
University,
1001
Sherbrooke
Street
West,
Montreal,
QC,
Canada
H3A
1G5
a
r
t
i
c
l
e
i
n
f
o
Article
history:
Available
online
14
October
2014
Keywords:
Service
triads
Service
recovery
Information
security
breach
Shareholder
value
Event
study
a
b
s
t
r
a
c
t
The
rise
in
front-end
service
outsourcing
in
recent
years,
despite
its
advantages,
has
also
exposed
buyer
firms
to
unique
challenges.
One
of
the
most
salient
risks
for
buyer
firms
in
service
triads
is
service
failure
due
to
the
service
provider.
Indeed
such
service
failures
may
be
more
costly
for
firms
due
to
the
greater
relational
and
operational
costs
that
may
arise
from
the
presence
of
the
third-party
provider.
Yet,
neither
the
services
literature
nor
extant
operations
literature
on
service
triads
has
paid
much
attention
to
the
financial
consequences
to
the
buyer
firm
–
i.e.,
service
risks
–
of
such
service
failures
in
triads.
To
fill
this
gap,
we
investigate
the
financial
penalty
of
service
failures
due
to
the
service
provider
using
the
event
study
methodology
and
a
sample
of
146
customer
information
security
breaches
as
our
empirical
context.
Analysis
of
the
abnormal
returns
reveals
that
service
failures
due
to
the
front-end
service
provider
lead
to
greater
shareholder
losses
than
such
failures
due
to
the
buyer
firm.
This
provides
important
new
insight
into
the
financial
risks
arising
from
outsourcing
front-end
services.
Further,
we
investigate
the
ability
of
the
buyer
firm’s
employee
and
financial
resources
to
temper
these
shareholder
losses.
We
find
that
buyer
firm
employee
productivity
can
moderate
the
greater
financial
penalty
associated
with
such
triadic
service
failures
but
that
buyer
firm
leverage
tends
to
not
have
such
a
mitigating
effect.
This
provides
new
guidance
for
theory
and
practice
regarding
how
buyer
firms
can
position
themselves
to
buffer
the
financial
risks
arising
from
service
failures
due
to
front-end
service
providers.
©
2014
Elsevier
B.V.
All
rights
reserved.
1.
Introduction
There
has
been
a
rapid
increase
in
services
outsourcing
in
recent
years
(e.g.,
Kalaignanam
et
al.,
2013),
with
latest
reports
indi-
cating
that
the
total
value
of
global
services
outsourcing
more
than
doubled
from
$45.6
billion
in
2000
to
$99.1
billion
in
2012
(Information
Service
Group,
2012).
In
response
to
the
growth
in
services
outsourcing,
researchers
in
operations
management
have
underscored
the
importance
of
continuing
investigations
into
the
phenomenon
(Schoenherr
et
al.,
2012;
Wynstra
et
al.,
2013).
Par-
ticularly,
it
has
been
emphasized
that
outsourcing
of
front-end
services
needs
to
be
investigated
in
more
detail,
since
these
lead
to
∗Corresponding
author.
Tel.:
+1
419
530
2258;
fax:
+1
419
530
2290.
E-mail
addresses:
sachin.modi@utoledo.edu
(S.B.
Modi),
michael.wiles@asu.edu
(M.A.
Wiles),
saurabh.mishra@mcgill.ca
(S.
Mishra).
1Tel.:
+1
480
956
2322;
fax:
+1
480
965
8000.
2Tel.:
+1
514
398
3487;
fax:
+1
514
398
3876.
triadic
structures
(i.e.,
relationships
encompassing
the
buyer
firm,
the
front-end
service
provider,
and
the
customers),
which
differ
substantially
from
the
traditional
dyadic
relationships
(i.e.,
buyer
firm-customers
and
buyer
firm-back-end
suppliers)
studied
in
the
operations
literature
(Choi
and
Wu,
2009).
Thus,
in
recent
years
a
growing
body
of
research
has
focused
on
understanding
supply
chain
triads
(e.g.,
Niranjan
and
Metri,
2008;
Wu
and
Choi,
2005).
Although
these
efforts
have
revealed
some
important
insights,
as
Li
and
Choi
(2009)
note
in
their
semi-
nal
work,
the
primary
focus
has
been
on
questions
such
as
“when
should
firms
outsource”
(e.g.,
Balakrishnan
et
al.,
2008;
Sridhar
and
Balachandran,
1997)
and
“what
activities
should
firms
outsource”
(e.g.,
van
der
Valk
et
al.,
2009;
Wu
and
Choi,
2005).
Yet,
there
remains
a
limited
understanding
of
the
financial
consequences
to
buyer
firms
–
i.e.,
service
risks
–
after
the
outsourcing
decision
for
front-end
services
has
been
made.
Further,
research
has
not
explored
the
role
of
buyer
firm
resources
in
signaling
their
abil-
ity
to
manage
the
financial
risks
emerging
from
front-end
services
outsourcing.
http://dx.doi.org/10.1016/j.jom.2014.10.003
0272-6963/©
2014
Elsevier
B.V.
All
rights
reserved.
22
S.B.
Modi
et
al.
/
Journal
of
Operations
Management
35
(2015)
21–39
In
this
research,
we
focus
on
these
two
under-investigated
facets
of
service
triads.
First,
we
investigate
if
triadic
service
failures
result
in
greater
shareholder
value
losses
for
buyer
firms
than
dyadic
fail-
ures
(for
ease
of
exposition,
we
refer
to
service
failures
at
front-end
service
providers
as
triadic
service
failures
and
service
failures
at
buyer
firms
as
dyadic
service
failures).
The
service
recovery
litera-
ture
suggests
that
effective
recovery
from
service
failures
requires
firms
to
adequately
address
customer
concerns
and
minimize
the
losses
to
their
customer
relationships
(e.g.,
Craighead
et
al.,
2004;
Miller
et
al.,
2000).
This
literature
further
underscores
that
service
recovery
calls
for
firms
to
quickly
find
the
faulty
processes
under-
pinning
the
failures
and
provide
a
fair
fix
to
these
(Craighead
et
al.,
2004;
Fang
et
al.,
2013;
Johnston
and
Michel,
2008).
In
other
words,
an
effective
service
recovery
strategy
rests
on
attending
to
both
customers
and
service
process
issues
emerging
from
the
service
failure.
Attending
to
these
two
issues
becomes
harder
in
triads,
as
front-end
service
outsourcing
has
the
potential
to
weaken
the
rela-
tionship
of
buyer
firms
with
customers
and
reduce
their
control
over
the
service
processes
outsourced
to
the
service
provider
(Li
and
Choi,
2009).
Together,
these
arguments
imply
that
buyer
firms
would
need
to
expend
greater
efforts
and
thus
incur
higher
ex-post
relational
and
operational
costs
following
triadic
service
failures.
Since
higher
costs
would
place
downward
pressure
on
future
firm
cash
flows,
it
is
expected
that
investors
would
account
for
triadic
versus
dyadic
settings
in
reacting
to
service
failure
announcements.
Second,
we
determine
if
two
resource
positions
of
buyer
firms,
i.e.,
high
employee
productivity
and
low
financial
leverage,
mod-
erate
their
shareholder
value
losses
from
triadic
service
failures.
To
effectively
implement
solutions
that
address
customer
con-
cerns
and
rectify
service
process
issues,
firms
need
to
deploy
both
employees
and
financial
resources
(Smith
et
al.,
1999).
Employees
help
to
assuage
customer
concerns
and
can
provide
expertise
to
correct
the
service
issues
to
potentially
prevent
them
from
happen-
ing
in
the
future
(e.g.,
Hays
and
Hill,
2001).
Further,
because
service
failures
can
have
a
significant
effect
on
the
operational
costs
of
firms
(e.g.,
Zhu
et
al.,
2004),
financial
resources
are
also
likely
to
play
an
important
role
in
service
recovery.
Since
we
expect
attending
to
customer
and
process
issues
is
likely
to
be
harder
in
triads,
superior
positions
in
these
two
resources
may
serve
as
especially
important
signals
to
investors
regarding
buyer
firms’
ability
to
temper
the
negative
effects
of
triadic
service
failures.
In
making
our
inquiry,
we
focus
on
one
particular
type
of
service
failure,
namely
customer
information
security
breaches.
These
neg-
ative
events
have
been
identified
as
one
of
the
most
substantial
service
failures
affecting
firms
(Malhotra
and
Malhotra,
2011).
As
such,
customer
information
security
breaches
provide
an
important
context
in
which
to
understand
service
risks
in
triads.
For
example,
in
2010
an
employee
at
an
outsourced
call-center
illegally
accessed
credit
card
information
of
Priceline
customers.
What
are
the
share-
holder
value
implications
of
such
triadic
service
failures
for
buyer
firms
like
Priceline?
Can
employee
and
financial
resources
of
buyer
firms
like
Priceline
help
lower
their
shareholder
losses
from
unex-
pected
customer
information
breaches,
especially
if
the
front-end
service
providers
lose
the
information?
These
are
important
issues
in
the
context
of
service
triads,
yet
research
has
not
investigated
them.
We
offer
a
conceptual
framework
that
integrates
insights
from
the
service
recovery
literature
(e.g.,
Craighead
et
al.,
2004;
Miller
et
al.,
2000)
and
literature
on
service
triads
(e.g.,
Li
and
Choi,
2009;
Niranjan
and
Metri,
2008)
to
answer
these
questions.
To
empiri-
cally
analyze
our
thesis,
we
focus
on
a
comprehensive
set
of
146
customer
information
security
breach
announcements
by
public
firms
between
the
years
2005
and
2010,
for
which
other
relevant
information
on
key
variables
was
available
from
secondary
sources.
Further,
to
maintain
our
focus
on
comparing
shareholder
costs
of
service
failures
in
triads
versus
dyads,
we
exclude
events
where
customer
information
was
lost
at
the
back-end
service
providers
in
our
analysis.
We
assess
investors’
reaction
to
customer
informa-
tion
security
breach
announcements
using
an
event
study
(Brown
and
Warner,
1985),
a
methodology
commonly
utilized
to
document
stock
market
reactions
to
OM-related
unexpected
external
events
(e.g.,
Hendricks
et
al.,
2009;
Jacobs
et
al.,
2010).
Our
hypotheses
are
then
tested
through
an
analysis
of
the
abnormal
returns
expe-
rienced
by
the
firms
following
the
breach
announcements.
Our
study
makes
two
central
contributions.
First,
we
reveal
that
the
unique
organizational
exchange
setting
inherent
in
service
tri-
ads
can
have
significant
adverse
financial
consequences
for
buyer
firms
in
the
face
of
unexpected
service
failures.
Extant
research
has
placed
limited
focus
on
understanding
triadic
service
failures
from
the
perspective
of
the
buyer
firms.
Our
theoretical
framework
artic-
ulates
the
shareholder
losses
to
buyer
firms
from
triadic
service
failures
in
detail,
and
by
doing
so
adds
to
the
understanding
of
service
risks
from
external
factors
in
triads,
a
topic
identified
for
more
research
attention
(Schoenherr
et
al.,
2012;
Wynstra
et
al.,
2013).
Second,
we
highlight
employee
and
financial
resources
as
two
critical
resource
positions
of
buyer
firms
which
can
attenu-
ate
the
shareholder
losses
of
triadic
service
failures.
The
role
of
employees
and
financial
resources
in
service
recovery
has
been
dis-
cussed
in
extant
literature
(e.g.,
Miller
et
al.,
2000;
Zhu
et
al.,
2004).
However,
much
of
the
focus
thus
far
has
been
on
assessing
cus-
tomer
evaluations
of
service
recovery
experiences.
To
the
best
of
our
knowledge,
ours
is
the
first
effort
to
explore
the
value
of
these
resources
as
signals
with
important
implications
for
shareholder
costs
of
triadic
service
failures
using
objective
financial
informa-
tion.
We
find
strong
empirical
support
for
the
role
of
employee
productivity
in
tempering
such
shareholder
losses.
Since
effective
management
of
shareholder
value
serves
as
the
primary
mandate
for
public
firms,
our
framework
helps
to
provide
actionable
guid-
ance
to
managers
and
furthers
both
the
literature
on
service
triads
and
service
recovery
in
operations
management.
Next,
we
present
our
conceptual
framework
followed
by
our
methodology
and
results.
We
close
with
implications
of
our
paper
and
discuss
avenues
for
future
research.
2.
Conceptual
framework
The
service
recovery
literature
emphasizes
the
need
for
firms
to
actively
engage
in
effective
recovery
following
service
failures
(e.g.,
Miller
et
al.,
2000;
Zhu
et
al.,
2004).
Indeed,
service
failures
have
the
potential
to
lower
customer
satisfaction
with
the
firm,
resulting
in
reduced
customer
retention
and
loyalty
(e.g.,
Fang
et
al.,
2013;
Hays
and
Hill,
1999;
Lapre,
2011).
Building
on
the
social
exchange
the-
ory
and
equity
theory
(e.g.,
Walster
et
al.,
1973,
1978),
the
service
recovery
literature
highlights
that
for
recovery
to
be
effective
in
tempering
the
loss
in
customer
relationships,
post-failure
efforts
by
firms
need
to
focus
on
providing
tangible
and
intangible
restitu-
tions
to
customers
that
are
commensurate
with
their
perceived
loss
(e.g.,
Craighead
et
al.,
2004;
Johnston
and
Michel,
2008).
In
addition,
service
recovery
is
argued
to
provide
firms
with
an
opportunity
to
look
at
the
“bigger
picture”
and
address
service
quality
issues
by
fixing
any
exposed
vulnerabilities
in
the
service
processes
(e.g.,
Roth
and
Menor,
2003).
Fixing
of
service
processes
can
help
re-
establish
the
quality
promise
to
customers
and
thus
help
firms
in
the
longer
term
(Craighead
et
al.,
2004).
Attending
to
customer
con-
cerns
and
service
process
issues,
however,
can
significantly
add
to
the
relational
and
operational
costs
of
the
firms
(e.g.,
Smith
et
al.,
1999).
Yet,
extant
research
has
not
focused
on
understanding
how
these
service
recovery
costs
would
play
out
in
the
context
of
service
triads.
Service
triads
provide
a
unique
exchange
framework,
where
service
quality
expectations
are
set
by
the
buyer
firms
but
service
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