The Use of Management Controls to Mitigate Risk in Strategic Alliances: Field and Survey Evidence

Abstract

ABSTRACT Transaction cost economics (TCE) theory is widely used to study the governance and management control practices used to mitigate interfirm alliance risk. Following Williamson (1985, 1991), empirical studies typically measure transaction characteristics that proxy for risk in alliances (e.g., asset specificity), and test for a relation between these measures and alliance management control choices. A common criticism of studies in this literature is that they typically focus on a narrow set of governance decisions (e.g., make versus buy) or control practices (e.g., specific contract terms). We posit that an equally limiting aspect of this literature is its reliance on risk proxies measured at the level of the individual transaction. These proxies fail to explicate specific alliance risks and, coupled with an undue focus on transactions rather than the totality of interfirm relationships, limit our understanding of how risks give rise to management controls more broadly defined. In this study we use field-based research and survey methods to develop a comprehensive inventory of the specific risks that managers anticipate and to provide insight regarding their prevalence across different types of interfirm alliances. Our analysis of the data supports an extant classification scheme that dichotomizes alliance risk as relational risk or performance risk (Das and Teng 1996, 2001). However, our analysis reveals another distinct risk category—compliance and regulatory risk—that figures prominently in accounting risk frameworks (i.e., COSO). Our exploratory analysis of correlation in the use of management controls, including contracts as well as pre- and post-contractual control processes, reveals six sets of alliance control practices. Relating these to risks, we find that performance risk is associated primarily with careful partner selection and contractual outcome agreements; relational risk is associated primarily with explicit exit agreements; and, compliance and regulatory risk is associated primarily with informal controls. In addition, we find that as compared to contractual alliances, alliances with shared ownership (i.e., joint ventures) make greater use of financial controls and informal controls. By identifying specific risks and controls used in practice and providing preliminary evidence of their relationships, this study provides a reference for future researchers seeking to provide more meaningful insight into the relationship between interfirm alliance risk environment and control systems.