Service provider and industrial customer’s opportunistic behaviors in the principal-agent-stakeholder triangle: A study on the role of registrar in ISO 9001 certification
By
ShaohanCai
Sprott School of Business,
Carleton University,
1125 Colonel By Drive,
710 Dunton Tower,
Ottawa, Ontario, K1S 5B6, Canada,
E-mail:
Minjoon Jun
Department of Management (MSC 3DJ),
College of Business,
New Mexico State University,
Las Cruces, NM 88003, U.S.A.,
E-mail:
ABSTRACT
When a service provider serves an industrial customer (i.e., a company), its performance not only affect the customer, but also various stakeholders of the customers. We argue the relationship among the three parties constitute a principal-agent-stakeholder triangle. We study such a triangle in ISO 9001 certification process, in which the auditee is the principal, the registrar firm is the agent, and the auditee’s customers are the stakeholders. We identify four groups of factors affecting the auditee and registrar’s opportunistic behaviors: (1) norms of conspiracy, (2) goal congruence and incongruence, (3) nature of exchange, and (4) design of contract. The effects of the opportunistic behaviors on the exchange outcomes in the triangle are also discussed.
[Key words]: agency theory, stakeholder theory, ISO 9001
A service providers is often regarded as an agent in a principal-agent relationship,in which a principal (the client) delegates authority to the agent (the service provider) to perform some service on its behalf (Hill and Jones, 1992). However, when a service provider serves an industrial customer (i.e., a company), its performance not only affect the customer, but also various stakeholders of the customers. For example, a credit rating agency (CRA) rates the securities offered by firms. The agency’s effectiveness in rating the securities not only affects these firms, but also stakeholders such as investors of the firms. In this case, there is a triangle consisting of three parties, such as a principal (firms issuing securities), an agent (CRA), and stakeholders (investors).
In this paper, we study the role of one particular type of service provider, ISO 9001 registrar, in a similar principal-agent-stakeholder triangle. We are especially interested in the antecedents and consequences of the registrar’s and the auditee’s opportunistic behaviors in the triangle.
Quality management is critical to any firm’s business success. Currently, the ISO9001 standard is one of the most popular guidelines for quality management systems. Yet, the effectiveness of the standard is somewhat controversial. Researchers have reported mixed results in terms of performance benefits in firms certified for the standard (e.g., Anderson et al., 1999; Benner and Veloso, 2008; Casadesus and Karapetrovic, 2005). Prior studies, however, have largely ignored the role of certification registrar, which is one major player in the certification process. Asservice providers,registrarsarecritical to the success of firms’ISO 9000 adoption and implementation.Itassists the firmsin instituting and refining theirquality management systemsthat meet the requirements of the standard, and perform auditsand determine whether the certification will be issued to them.
However, there is a conflict of interest in the roles played by registrars. The registrars are paid by the firms that they are auditing. This creates a problem similar to that of the CRA. A CRArates the securities offered by firms butisalso paid by the firms. A CRA’s business is mostly governed by reputation: a rating issued by a prestigious agency is more likely to be accepted in the market than by an unknown one. Even so, the 2008 financial crisis revealed that many CRAs indeed did not strictly and objectively rate their clients. For ISO 9000 registrars, the reputation governance could be even weaker: Most industrial buyers tend not to distinguish between the certifications issued by different registrars. Thus, the motive of relaxing requirements to satisfy clients is relatively strong for these registrars (Yeung and Mok, 2005).
Additionally, there are various stakeholders of the certification process, such as an auditee’s trading partners, consumers, stockholders, creditors, local communities, etc. The stakeholders may refer to the certification when judging the auditee’s capability in quality management. However, these stakeholders canneither directly involve in the certification process nor influence it. Therefore, they are vulnerable to the opportunistic behaviors of the auditee and/or the registrar.
As such, in the relationships among an auditee, a registrar, and stakeholders, three types of opportunistic behaviors may occur: (1) between the registrar and the auditee, the registrar may not make sufficient effort to assist the auditeein implementing the standard and obtainingthe certification; (2) between the auditee and the stakeholders, the auditee may attempt to obtain the certification without fully complying with the standard, which may hurt the interests of the stakeholders, especially the auditee’s customers; and (3) between the registrar and the stakeholders, the registrar may take a “profit-oriented and business-friendly” auditing approach to retain clients (Yeung and Mok, 2005). As in the second case, a certification issued in such an unethical way could hurt the interests of the stakeholders.
Therefore, our understanding of the mechanisms determining the effectiveness of ISO 9000 certification remains unclear, if the interrelationshipsbetweenthe auditee, the registrar, and the stakeholder group are not thoroughly examined.In this paper, we adopt both agency and stakeholder theories to explain the opportunistic behaviors and control mechanisms in the triangle relationship. We maintain that a principal-agency relationship exists between the auditee and the registrar. We also focus on one major stakeholder of the certification: the customers of anauditee, who may rely on the certification to judge the auditee’s quality capability. As such, these three actors form a triangle consisting of a principal, an agent, andstakeholders. We thus argue that investigating the dynamics of the triangle relationship could offer critical insights into the opportunistic behaviors in the third party auditing process. In the following sections, we present our theoretical foundations, research proposition, and conclusion.
ISO 9001 CERTIFICATION
The ISO 9000 series of quality standards were first published by a technical committee (TC 176) of the International Organization for Standardization (ISO) in 1987 (Anderson et al., 1999). The ISO 9000 family currently consists of 17 different quality standards (International Organization for Standardization, 2009). Among them, ISO 9001 is the most widely adopted. ISO 9001 specify requirements on five aspects of quality management systems: (1) General requirements for the system and documentation, (2) Management responsibility, (3) Resource management, (4) Product realization, and (5) Measurement, monitoring, analysis and improvement (International Organization for Standardization, 2008).
The purpose of ISO 9001 certification is two folds: (1) to allow firms to demonstrate their ability to do quality management, and (2) to enable firms to enhance buyer satisfaction through the effective application of the quality system (International Organization for Standardization, 2008). The European community (EU) was first to adopt the standard as an import-export standard, and influenced many other countries to follow suit (Albuquerque et al., 2007; Anderson et al., 1999). Consequently, ISO 9001 has been widely adopted by many firms in the world as a selection tool for trading partners(Boiral and Veloso, 2007; Clougherty and Grajek, 2008)
The ISO 9001 certification mechanism consists of three components: (1) Country accrediting agencies, which certify the competence of third party registrars and maintain the records of certified sites. There is one accrediting agency in each country. (2) Registrar firms, which offer ISO certification service; and (3) Individual auditors from the registrar firms, who attest to a site’s compliance with the standards (Anderson et al., 1999). The auditors are those with whom firms seeking certification should interact.
As suggested by ISO, most registrars take a two-stage approach to auditing. The first stage is primarily for scoping and planning a certification audit. This allows the auditor to communicate with the auditee to obtain an understanding of the organization. The second stage is the actual certification audit (International Organization for Standardization, 2009). During the processes, the auditor identifies nonconformity and the auditee makes necessary adjustments, which allow theauditee to obtain certification later (Boiral, 2003). Indeed, since ISO 9000 only provides very general principles, the registrar has to become the interpreter of the standard, and in most case, the best sources of guidance for the implementation of the standard(Bamford and Deibler, 1997). In this sense, a registrar indeed plays two roles: (1) to help auditees to implement ISO 9000; and (2) to evaluate auditees’ performance. The effectiveness of the registrar needs to be evaluated based on these two roles.
THEORETICAL FOUNDATIONS
Agency theory and stakeholder theory
We draw upon agency theory and stakeholder theory to develop our research framework. The classic agency theory suggests that the principaland the agent may not share common interests. The most common form of such a principal-agent relationship is the one between a firm’s stockholders (principal) and its managers (agent) (Shankman, 1999). The agent may take actions to maximize his own interest, but those actions may not enhance, sometimes even hurt, the principal’s interest. (Jacobides and Croson, 2001). However, it is difficult or expensive for the principal to monitor the agent (Eisenhardt, 1989). This constitutes so-called the “agency problem” or “principal-agent problem”. Thus, various mechanisms are needed to protect the interest of the principal, such as monitoring the agent’s behaviors, and behavior- or outcome–oriented contracts (Eisenhardt, 1989). To date, many researchers have adopted the agency theory to explain the relationship between trading partners and maintained that a principal-agent relationship exists between actors, such as buyers and suppliers (for a comprehensive review, see Fayezi et al., 2012).
Whereas the classical agency theory focuses on the one-to-one principal and agent relationship, such asa buyer vs. a supplier, the stakeholder theory addressesthe relationships between a firm’s manager and its multiple stakeholders. Freeman (1984) defines stakeholders as any individual or group having an interest in, or being affected by, the corporation.He further defines those parties having a formal, official, or contractual relationship with a firm as primary stakeholders, and others as secondary stakeholders. The stakeholder theory thus argues that managers need to strike a balance among the interests of all stakeholders, thereby ensuring the survival of the firm and /or the attainment of other performance goals (Shankman, 1999). Mitchell et al. (1997)points out that managers need to allocate their attention and resources to satisfy various stakeholders based on three key attributes: (1) legitimacy, which refers to whether a stakeholder has a legitimate claim over the firm based on contract, exchange, legal title, legal right, moral right, at-risk status, or moral interest in the harms and benefits generated by company actions; (2) power, which refers to the stakeholder’s ability to influence a firm’s behaviors; and (3) urgency, which refers to the degree to which a stakeholder’s claim calls for immediate attention from managers.
Conversely, as suggested by Frooman (1999), stakeholdersare able to influence a firm in four ways: (1) direct withholding, where stakeholders decide not to allocate their resources to a firm; (2) direct usage, where stakeholders continue to supply resources to a firm, but with conditions attached; (3) indirect withholding, where stakeholders work with an ally, whichstops allocating its resources to a firm; and (4) indirect usage, where stakeholders work with an ally, which supplies resources to a firm, but with conditions attached. Additionally, it is also argued that the extent of stakeholders’ influence is affected by their power and legitimacy (Eesley and Lenox, 2006). In this paper, we focus on a firms’ customers as stakeholders.
Although the agency theory and stakeholder theory have different sets of assumptions and processes, some researchers have made efforts to integrate these two theoretical approaches(Fontrodona and Sison, 2006; Hill and Jones, 1992; Shankman, 1999). Arguably, the stockholder is one of the major stakeholders of a firm. Thus, the principal (stockholders)-agent (management) relationship could be viewed as a subset of the broad stakeholder-agent relationships(Hill and Jones, 1992). Meanwhile, these researchers have criticized the assumptions of the agency theory and made adjustments accordingly. The agency theory originates from organizational economics (Shankman, 1999) and operates on the assumption that markets are efficient and quickly adjust to new circumstances (Hill and Jones, 1992).However, Hill and Jones (1992) points out that there are frictions in the market adjustment process, such as barriers to entry or exit, and organizational inertia. Because of these frictions, once created, the disequilibrium conditions in market may persist for a prolonged period of time before an efficient equilibrium is re-established.
On the other hand, Shankman (1999) maintains that the agency theory is a narrow form of the stakeholder theory. He points out that the agency theory only recognizes the economic responsibilities between the principal and the agent, and that the interest of the principal is viewed as having primary importance. However,the following four minimum moral principles are already embedded in economic theories of market competition and in agency relationships: (1) honoring agreements, (2) avoiding lying, (3) respecting the autonomy of others, and (4) avoiding harm to others. Therefore, the original claims of the agency theory, which emphasize that agents,such as managers, must act only in the principals’ (owners) interest, must be exercised according to the four principles. In other words, the agency relationship is constrained by the moral principles derived from the logic and context of the market itself.Shankman (1999) thus argues that the agency theory must include a recognition of stakeholders. He further points out that the agency theory consists of contradictory assumptions: the theory assumes egoism, while at the same time, it implicitly recognizes the four moral principles, and thus assumes that individuals are able to act in altruistic ways. To resolve the conflicts, Shankman (1999) suggests that humanistic, social, and ethnically centered perspectives of firms, such as those advocated by the stakeholder theory, must be integrated into the agency theory. Accordingly, he argues thatthe agency theory can be subsumed within a general stakeholder model of the firm.
The principal-agent-stakeholder triangle in ISO 9001 certification
The concept of a principal-agent-stakeholder triangle can be found in a situation where a principal hires an agent to work on the principal’s behalf, and in turn the agent’s work affectsthe interests of both the principal and the principal’s stakeholders. We examine, from the auditee’s perspective,unanswered research issues concerningthe relationships between three key entities of the ISO 9001 certification. They are an auditee, a registrar, and auditee’s customers. These entities are regarded as a principal, an agent, and stakeholders of the principal-agent relationship, respectively. Figure 1 depicts the triangle relationships from the auditee’s perspective. Importantly, although there is no direct interaction between the registrar firm and the customers, the actions by the registrar firm can greatly affect the customers’ interest. For example, an invalid certification may mislead the customers’ judgment regarding the auditee’sproduct/service qaulity. Since there is no contractual relationship between them, the customers can be considered secondary stakeholders of the registrar firm (Freeman, 1984).
In a principal-agent relationship, there are two types of agent opportunistic behaviors, namely, lack of an agent’s effort when act on the principal’s behalf (Moral hazard) and agent misrepresenting its capability (adverse selection) (Eisenhardt, 1989; Fleisher, 1991). We maintain that these two types of opportunistic behaviors could also be found in astakeholder-agent relationship. Furthermore, from the perspective of stakeholder theory, there is another type of opportunistic behaviors: inappropriately meet the demand of one stakeholder at the cost of the other (hereafter, we label it as “unethical tradeoff”). Recall Mitchell et al.’s(1997) three key criteria for allocation of resources among stakeholders: legitimacy, power, and urgency. When making tradeoff among stakeholders’ interests, managers need to make an ethical decision based upon the three key criteria. However, as noted by Mitchell et al. (1997), managers often place a high priority on power, thus stakeholders lacking power are neglected or given a low priority. As mentioned earlier, the customersforan auditee’s productsare considered a stakeholder of the registrar. Most of thesescustomers fall into the category of Mitchell et al.’s(1997) discretionary stakeholders, which possess the attribute of legitimacy, but have no power to influence an organization and have no urgent claims. Thus, theauditee’s customers are very likely to be neglected by the registrar, and the registrar may scarify their interest to retain clients (auditees). There is one exception, though. Some industrial buyers demand that auditing be done by a designated, reputable registrar(Yeung and Mok, 2005), or even hire an auditor by themselves. These customersare often large multinational corporations, which have strong power over industrial suppliers (auditees). In this case, the registrars are less likely to relax their requirements for the auditees.
Thus, in the triangle relationship, the registrar may act opportunistically in twoways.First, the registrar does not make sincere effort to accurately evaluate the auditee’s performance, which leads to the certification of unqualified firms. Such behaviorcould constitute a “moral hazard” problem, if the primary goal of the auditee is to improve its quality management system. The reason is that by offering an “easy certification”, the registrar reduces its own workload in assisting the auditee. Such opportunistic behavior could also be regarded as an “unethical tradeoff” problem,if the auditee demands a quick certification and the registrar deliberately relaxes its standard to meet such a demand. As a result, the registrar satisfies the auditee at the expense of the buyer’s interest.Second, the registrar does not make sincere effort to effectively assist the auditeein improvingits quality management system, which constitutes a “moral hazard” problem. Finally, the registrar may sell unnecessary training programs to their clients. In this case, the registrar misrepresents the effectiveness of its training program. This constitutes an “adverse selection” problem.
Similarly, the auditee may act opportunistically. Even thoughthe auditee does not faithfully comply with ISO 9001 standards, itmay manage to obtain the certification by cheating the auditor. This is consideredan “unethical tradeoff”, since the behaviors benefit the stockholder of the auditee at the expense of the customer and/or the registrar (the registrar’s reputation is at risk).