Third-Party Monitoring and Risk Management: A Literature Review

Abstract

Abstract Although risk management is prevalent in organizations, agency theory studies on contractual relationships in firms fail to address it. Risk reduction is mostly discussed within the context of monitoring, understood as insight into the activities of subordinates. Hence, this literature review discusses 18 main analytical studies on monitoring, reviewing whether they can be reinterpreted as depicting risk management, thereby allowing for the transfer of gained insights. Accordingly, only Meth, B. (1996). Reduction of outcome variance: optimality and incentives. Contemp. Account. Res. 13: 309–328 and Dürr, O., Nisch, M., and Rohlfing-Bastian, A. (2020). Incentives in optimized teams for projects with uncertain returns. Rev. Account. Stud. 25: 313–341, can be reinterpreted as such, bearing the following risk management implications: (1) risk management is vital for firms, as firm’s risk affects employee incentive contracts, firm’s utility, and optimal firm size; (2) risk attitudes of risk managers are crucial for designing incentive contracts, with incentives necessary for more (less) risk-averse agents to encourage risk-taking (risk reduction); and (3) risk management should be delegated as a task separate from other managerial activities. The other studies do not depict risk management. Therefore, many research subjects remain open, such as organizing risk management in hierarchies, delegating risk management as a task and incentivizing it when a firm’s outcome is unavailable for contracting, and establishing the connection between the performance measures and the risk of a firm.