The outsourcing of risk management is affected by a variety of factors. By drawing on survey data as well as companies’ annual reports, the authors attempt to explain which factors lead to an outsourcing decision and which factors lead to internal governance. These factors are ascribed to a firm’s transaction cost model and appear to be mainly related to asset specificity, uncertainty, and transaction frequency.
How Is This Research Useful to Practitioners?
The authors find that higher asset-specific risk management relative to other service functions is more likely to result in retaining risk management services in-house. In addition, they find that firms subject to greater environmental uncertainty (technological change) and behavioral uncertainty (degree of competition and transaction frequency) are less likely to make the decision to outsource. In contrast, environmental uncertainty arising from a greater degree of adaptation in risk management, recent restructurings, or number of subsidiaries, as well as behavioral uncertainty related to recent managerial change, is more likely to lead to more outsourcing.
This research will be of interest to any analyst examining a company’s risk management sourcing and trying to identify the relevant inputs into such a decision.
How Did the Authors Conduct This Research?
Questionnaires were sent to 1,641 Australian companies listed on the ASX as of 31 December 2009, one full reporting year after the implementation of ASX Corporate Governance Council Principle 7 (Recognise and Manage Risk). The questions focused on such dependent variables as the nature and proportion of the risk management services outsourced, as well as independent variables. Of the companies approached, 281 responded.
The authors identify eight binary measurement categories for the dependent variables and group the independent variables by asset specificity, environmental and behavioral uncertainty, and transaction frequency. The proportion of expenditures on research and development is used as a proxy for asset specificity, alongside additional analyses of staff turnover and contract duration. Environmental uncertainty is measured on the basis of the number of subsidiaries, overseas revenue, recent restructurings, sales volatility, and change in management, as well as survey responses regarding the modifications required to adapt risk management. To assess behavioral uncertainty, three measures are used: the competitive environment (Herfindahl index), the completeness of the outsourced contracts for risk management services, and the relative advantage of having established management—as opposed to new management—on the performance evaluation staff. Finally, frequency of transactions and company size are measured using the number of employees, operating revenue, and total assets. A number of control variables are used, including knowledge transfer costs, the use of a “Big 4” auditor, and capital intensity. The authors find that their respondents are typically larger and have been operating for a longer time than the average ASX-listed company, but they find insufficient evidence that this response bias has any impact on their results.
Abstractor’s Viewpoint
This research is a helpful descriptive summary of some of the dimensions of the decision to outsource risk management. It fails to suggest, however, whether all these behaviors are a consequence of transaction cost minimization or whether there may be imposed constraints or inertial reasons favoring one type of service sourcing. This study does not address the validity of a firm’s transaction cost model and is subject to the limitations of any study based on survey data. For practitioners interested in the outsourcing of risk management, further research could add a great deal of value by broadening the perspective offered by the authors.