The Information Technology Outsourcing Risk: A Transaction Cost and Agency Theory-Based Perspective

Abstract

Many firms have adopted outsourcing in recent years as a means of governing their information technology (IT) operations. While outsourcing is associated with significant benefits, it can also be a risky endeavour. This paper proposes a scenario-based conceptualization of the IT outsourcing risk, wherein risk is defined as a quadruplet comprising a scenario, the likelihood of that scenario, its consequences and the risk mitigation mechanisms that can attenuate or help avoid the occurrence of a scenario. This definition draws on and extends a risk assessment framework that is widely used in engineering. The proposed conceptualization of risk is then applied to the specific context of IT outsourcing using previous research on IT outsourcing as well as transaction cost and agency theory as a point of departure.

Knowing about your food from the farm to the table: Using information systems that reduce information asymmetry and health risks in retail contexts

“…For example, individual perceptions of institutions have been studied with factors such as perceived monitoring, perceived accreditation, and perceived legal bonds for the purpose of resolving principal agent issues [93]. In a similar vein, other studies explain the role of institutions in reducing information asymmetry in diverse contexts, including information system consulting [62], institution-based remedies in e-retailing [55,150,153], information technology outsourcing [18], and consumer behavior in electronic commerce [12]. We draw from these studies in our theoretical development, which we discuss in the following paragraphs.…”

How project description length and expected duration affect bidding and project success in crowdsourcing software development

“…Moral hazard risks: Once an agent has been chosen and the contract has been signed, the principal faces another set of risks that relate to not knowing exactly what the agent is actually doing. This is especially pertinent in the world of software development and related services where it is practically impossible to verify that developers are not wasting time, are not skipping or skimping on testing, and that they are writing the code in a reasonably efficient manner (Bahli and Rivard, 2003;Lacity and Reynolds, 2014). 3.…”

“…Agency Theory has proved very effective in studying larger sized software outsourcing projects as seen from a principal's risk perspective (Bahli and Rivard, 2003;Lacity et al, 2010;McLeod and MacDonell, 2011). Agency Theory has been applied also to understanding the behavior of principals in CSM (Carmel and Tjia, 2005;Gefen and Carmel, 2008;Gefen and Carmel, 2013;Snir and Hitt, 2003;Snir and Hitt, 2004), but little is known about the agents in a CSM context, i.e.…”

“…Such information asymmetry is common also in software outsourcing . Indeed, it is practically impossible to verify the quality of software testing and documentation by its developers in outsourcing contexts (Bahli and Rivard, 2003). As the principal cannot possibly know as much as each agent knows about itself, the principal faces the risk of being taken unduly advantage of by the agents.…”

IT outsourcing and firm-level performance: A transaction cost perspective

“…IT outsourcing puts the support activity outside the organization's internal environment and may result in lower service levels from an end-user's perspective. Furthermore, outsourcing is susceptible to risk factors like antiquated technology lock-in, high-cost of contractual modifications, unanticipated management and transition costs, and legal disputes [3].…”