Value of audit for supply chains with hidden action and information

Mohammad E. Nikoofal and Mehmet Gümüş

European Journal of Operational Research, 2020, vol. 285, issue 3, 902-915

Abstract: Outsourcing can provide firms with a competitive advantage by realizing the benefits of suppliers’ low labor, better quality and improved innovation. Yet, the supply chain managers have several concerns about outsourcing which are mainly due to lack of critical information regarding the actions of their suppliers. In this paper, we study the effectiveness of auditing the supplier’s hidden actions for the buyer (principal) when the supplier (agent) is privately informed about the extent of the supply risk. In order to accomplish this, we first extend the standard principal-agent model by considering a case in which the agent’s hidden action affects the extent of information asymmetry between principal and agent. By comparing the agency costs associated with the optimal menu of contracts with and without audit, we then completely characterize the value of audit from the perspectives of both buyer and supplier as well as total supply chain. First, the analysis of value of audit from the buyer’s perspective shows that the buyer can strictly benefit from auditing the supplier’s actions. Second, we find that not only the buyer but also the supplier can strictly benefit from an audit. Third, the audit enables the buyer to customize her contract offerings based on the reliability of the supplier. Finally, by analyzing the impact of problem parameters on the value of the audit, we identify the conditions under which an audit would be beneficial for individual supply chain parties as well as the overall supply chain.

Keywords: Cost benefit analysis; Supply contracts; Adverse selection; Moral hazard; Audit (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:285:y:2020:i:3:p:902-915

DOI: 10.1016/j.ejor.2020.02.024

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