Service provider and industrial customer’s opportunistic behaviors in the principal-agent-stakeholder triangle: A study on the role of registrar in ISO 9001 certification

By

Shaohan CaiSprott School of Business,

Carleton University, 1125 Colonel By Drive,

710 Dunton Tower, Ottawa, Ontario, K1S 5B6, Canada,

E-mail: acai@sprott.carleton.ca

Minjoon JunDepartment of Management (MSC 3DJ),

College of Business, New Mexico State University,

Las Cruces, NM 88003, U.S.A., E-mail : minjun@nmsu.edu

ABSTRACT1

When a service provider serves an industrial customer (i.e., a company), its performance not

only affect the customer, but also various stakeholders of the customers. We argue the relationship

among the three parties constitute a principal-agent-stakeholder triangle. We study such a triangle

in ISO 9001 certification process, in which the auditee is the principal, the registrar firm is the

agent, and the auditee’s customers are the stakeholders. We identify four groups of factors

affecting the auditee and registrar’s opportunistic behaviors: (1) norms of conspiracy, (2) goal

congruence and incongruence, (3) nature of exchange, and (4) design of contract. The effects of

the opportunistic behaviors on the exchange outcomes in the triangle are also discussed.

[Key words]: agency theory, stakeholder theory, ISO 9001

A service providers is often regarded as an agent in a principal-agent relationship, in which a

principal (the client) delegates authority to the agent (the service provider) to perform some

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service on its behalf (Hill and Jones, 1992). However, when a service provider serves an

industrial customer (i.e., a company), its performance not only affect the customer, but also

various stakeholders of the customers. For example, a credit rating agency (CRA) rates the

securities offered by firms. The agency’s effectiveness in rating the securities not only affects

these firms, but also stakeholders such as investors of the firms. In this case, there is a triangle

consisting of three parties, such as a principal (firms issuing securities), an agent (CRA), and

stakeholders (investors).

In this paper, we study the role of one particular type of service provider, ISO 9001 registrar,

in a similar principal-agent-stakeholder triangle. We are especially interested in the antecedents

and consequences of the registrar’s and the auditee’s opportunistic behaviors in the triangle.

Quality management is critical to any firm’s business success. Currently, the ISO 9001

standard is one of the most popular guidelines for quality management systems. Yet, the

effectiveness of the standard is somewhat controversial. Researchers have reported mixed results

in terms of performance benefits in firms certified for the standard (e.g., Anderson et al., 1999;

Benner and Veloso, 2008; Casadesus and Karapetrovic, 2005). Prior studies, however, have

largely ignored the role of certification registrar, which is one major player in the certification

process. As service providers, registrars are critical to the success of firms’ ISO 9000 adoption

and implementation. It assists the firms in instituting and refining their quality management

systems that meet the requirements of the standard, and perform audits and determine whether the

certification will be issued to them.

However, there is a conflict of interest in the roles played by registrars. The registrars are

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paid by the firms that they are auditing. This creates a problem similar to that of the CRA. A CRA

rates the securities offered by firms but is also paid by the firms. A CRA’s business is mostly

governed by reputation: a rating issued by a prestigious agency is more likely to be accepted in

the market than by an unknown one. Even so, the 2008 financial crisis revealed that many CRAs

indeed did not strictly and objectively rate their clients. For ISO 9000 registrars, the reputation

governance could be even weaker: Most industrial buyers tend not to distinguish between the

certifications issued by different registrars. Thus, the motive of relaxing requirements to satisfy

clients is relatively strong for these registrars (Yeung and Mok, 2005).

Additionally, there are various stakeholders of the certification process, such as an

auditee’s trading partners, consumers, stockholders, creditors, local communities, etc. The

stakeholders may refer to the certification when judging the auditee’s capability in quality

management. However, these stakeholders can neither directly involve in the certification process

nor influence it. Therefore, they are vulnerable to the opportunistic behaviors of the auditee

and/or the registrar.

As such, in the relationships among an auditee, a registrar, and stakeholders, three types

of opportunistic behaviors may occur: (1) between the registrar and the auditee, the registrar may

not make sufficient effort to assist the auditee in implementing the standard and obtaining the

certification; (2) between the auditee and the stakeholders, the auditee may attempt to obtain the

certification without fully complying with the standard, which may hurt the interests of the

stakeholders, especially the auditee’s customers; and (3) between the registrar and the

stakeholders, the registrar may take a “profit-oriented and business-friendly” auditing approach to

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retain clients (Yeung and Mok, 2005). As in the second case, a certification issued in such an

unethical way could hurt the interests of the stakeholders.

Therefore, our understanding of the mechanisms determining the effectiveness of ISO

9000 certification remains unclear, if the interrelationships between the auditee, the registrar, and

the stakeholder group are not thoroughly examined. In this paper, we adopt both agency and

stakeholder theories to explain the opportunistic behaviors and control mechanisms in the triangle

relationship. We maintain that a principal-agency relationship exists between the auditee and the

registrar. We also focus on one major stakeholder of the certification: the customers of an auditee,

who may rely on the certification to judge the auditee’s quality capability. As such, these three

actors form a triangle consisting of a principal, an agent, and stakeholders. We thus argue that

investigating the dynamics of the triangle relationship could offer critical insights into the

opportunistic behaviors in the third party auditing process. In the following sections, we present

our theoretical foundations, research proposition, and conclusion.

ISO 9001 CERTIFICATION

The ISO 9000 series of quality standards were first published by a technical committee

(TC 176) of the International Organization for Standardization (ISO) in 1987 (Anderson et al.,

1999). The ISO 9000 family currently consists of 17 different quality standards (International

Organization for Standardization, 2009). Among them, ISO 9001 is the most widely adopted. ISO

9001 specify requirements on five aspects of quality management systems: (1) General

requirements for the system and documentation, (2) Management responsibility, (3) Resource

management, (4) Product realization, and (5) Measurement, monitoring, analysis and

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improvement (International Organization for Standardization, 2008).

The purpose of ISO 9001 certification is two folds: (1) to allow firms to demonstrate their

ability to do quality management, and (2) to enable firms to enhance buyer satisfaction through

the effective application of the quality system (International Organization for Standardization,

2008). The European community (EU) was first to adopt the standard as an import-export

standard, and influenced many other countries to follow suit (Albuquerque et al., 2007; Anderson

et al., 1999). Consequently, ISO 9001 has been widely adopted by many firms in the world as a

selection tool for trading partners (Boiral and Veloso, 2007; Clougherty and Grajek, 2008)

The ISO 9001 certification mechanism consists of three components: (1) Country

accrediting agencies, which certify the competence of third party registrars and maintain the

records of certified sites. There is one accrediting agency in each country. (2) Registrar firms,

which offer ISO certification service; and (3) Individual auditors from the registrar firms, who

attest to a site’s compliance with the standards (Anderson et al., 1999). The auditors are those

with whom firms seeking certification should interact.

As suggested by ISO, most registrars take a two-stage approach to auditing. The first

stage is primarily for scoping and planning a certification audit. This allows the auditor to

communicate with the auditee to obtain an understanding of the organization. The second stage is

the actual certification audit (International Organization for Standardization, 2009). During the

processes, the auditor identifies nonconformity and the auditee makes necessary adjustments,

which allow the auditee to obtain certification later (Boiral, 2003). Indeed, since ISO 9000 only

provides very general principles, the registrar has to become the interpreter of the standard, and in

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most case, the best sources of guidance for the implementation of the standard (Bamford and

Deibler, 1997). In this sense, a registrar indeed plays two roles: (1) to help auditees to implement

ISO 9000; and (2) to evaluate auditees’ performance. The effectiveness of the registrar needs to

be evaluated based on these two roles.

THEORETICAL FOUNDATIONS

Agency theory and stakeholder theory

We draw upon agency theory and stakeholder theory to develop our research framework. The

classic agency theory suggests that the principal and the agent may not share common interests.

The most common form of such a principal-agent relationship is the one between a firm’s

stockholders (principal) and its managers (agent) (Shankman, 1999). The agent may take actions

to maximize his own interest, but those actions may not enhance, sometimes even hurt, the

principal’s interest. (Jacobides and Croson, 2001). However, it is difficult or expensive for the

principal to monitor the agent (Eisenhardt, 1989). This constitutes so-called the “agency problem”

or “principal-agent problem”. Thus, various mechanisms are needed to protect the interest of the

principal, such as monitoring the agent’s behaviors, and behavior- or outcome–oriented contracts

(Eisenhardt, 1989). To date, many researchers have adopted the agency theory to explain the

relationship between trading partners and maintained that a principal-agent relationship exists

between actors, such as buyers and suppliers (for a comprehensive review, see Fayezi et al.,

2012).

Whereas the classical agency theory focuses on the one-to-one principal and agent

relationship, such as a buyer vs. a supplier, the stakeholder theory addresses the relationships

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between a firm’s manager and its multiple stakeholders. Freeman (1984) defines stakeholders as

any individual or group having an interest in, or being affected by, the corporation. He further

defines those parties having a formal, official, or contractual relationship with a firm as primary

stakeholders, and others as secondary stakeholders. The stakeholder theory thus argues that

managers need to strike a balance among the interests of all stakeholders, thereby ensuring the

survival of the firm and /or the attainment of other performance goals (Shankman, 1999).

Mitchell et al. (1997) points out that managers need to allocate their attention and resources to

satisfy various stakeholders based on three key attributes: (1) legitimacy, which refers to whether

a stakeholder has a legitimate claim over the firm based on contract, exchange, legal title, legal

right, moral right, at-risk status, or moral interest in the harms and benefits generated by company

actions; (2) power, which refers to the stakeholder’s ability to influence a firm’s behaviors; and

(3) urgency, which refers to the degree to which a stakeholder’s claim calls for immediate

attention from managers.

Conversely, as suggested by Frooman (1999), stakeholders are able to influence a firm in

four ways: (1) direct withholding, where stakeholders decide not to allocate their resources to a

firm; (2) direct usage, where stakeholders continue to supply resources to a firm, but with

conditions attached; (3) indirect withholding, where stakeholders work with an ally, which stops

allocating its resources to a firm; and (4) indirect usage, where stakeholders work with an ally,

which supplies resources to a firm, but with conditions attached. Additionally, it is also argued

that the extent of stakeholders’ influence is affected by their power and legitimacy (Eesley and

Lenox, 2006). In this paper, we focus on a firms’ customers as stakeholders.

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Although the agency theory and stakeholder theory have different sets of assumptions and

processes, some researchers have made efforts to integrate these two theoretical approaches

(Fontrodona and Sison, 2006; Hill and Jones, 1992; Shankman, 1999). Arguably, the stockholder

is one of the major stakeholders of a firm. Thus, the principal (stockholders)-agent (management)

relationship could be viewed as a subset of the broad stakeholder-agent relationships (Hill and

Jones, 1992). Meanwhile, these researchers have criticized the assumptions of the agency theory

and made adjustments accordingly. The agency theory originates from organizational economics

(Shankman, 1999) and operates on the assumption that markets are efficient and quickly adjust to

new circumstances (Hill and Jones, 1992). However, Hill and Jones (1992) points out that there

are frictions in the market adjustment process, such as barriers to entry or exit, and organizational

inertia. Because of these frictions, once created, the disequilibrium conditions in market may

persist for a prolonged period of time before an efficient equilibrium is re-established.

On the other hand, Shankman (1999) maintains that the agency theory is a narrow form of

the stakeholder theory. He points out that the agency theory only recognizes the economic

responsibilities between the principal and the agent, and that the interest of the principal is

viewed as having primary importance. However, the following four minimum moral principles

are already embedded in economic theories of market competition and in agency relationships:

(1) honoring agreements, (2) avoiding lying, (3) respecting the autonomy of others, and (4)

avoiding harm to others. Therefore, the original claims of the agency theory, which emphasize

that agents, such as managers, must act only in the principals’ (owners) interest, must be

exercised according to the four principles. In other words, the agency relationship is constrained

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by the moral principles derived from the logic and context of the market itself. Shankman (1999)

thus argues that the agency theory must include a recognition of stakeholders. He further points

out that the agency theory consists of contradictory assumptions: the theory assumes egoism,

while at the same time, it implicitly recognizes the four moral principles, and thus assumes that

individuals are able to act in altruistic ways. To resolve the conflicts, Shankman (1999) suggests

that humanistic, social, and ethnically centered perspectives of firms, such as those advocated by

the stakeholder theory, must be integrated into the agency theory. Accordingly, he argues that the

agency theory can be subsumed within a general stakeholder model of the

firm.

The principal-agent-stakeholder triangle in ISO 9001 certification

The concept of a principal-agent-stakeholder triangle can be found in a situation where a

principal hires an agent to work on the principal’s behalf, and in turn the agent’s work affects the

interests of both the principal and the principal’s stakeholders. We examine, from the auditee’s

perspective, unanswered research issues concerning the relationships between three key entities

of the ISO 9001 certification. They are an auditee, a registrar, and auditee’s customers. These

entities are regarded as a principal, an agent, and stakeholders of the principal-agent relationship,

respectively. Figure 1 depicts the triangle relationships from the auditee’s perspective.

Importantly, although there is no direct interaction between the registrar firm and the customers,

the actions by the registrar firm can greatly affect the customers’ interest. For example, an invalid

certification may mislead the customers’ judgment regarding the auditee’s product/service qaulity.

Since there is no contractual relationship between them, the customers can be considered

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secondary stakeholders of the registrar firm (Freeman, 1984).

In a principal-agent relationship, there are two types of agent opportunistic behaviors,

namely, lack of an agent’s effort when act on the principal’s behalf (Moral hazard) and agent

misrepresenting its capability (adverse selection) (Eisenhardt, 1989; Fleisher, 1991). We maintain

that these two types of opportunistic behaviors could also be found in a stakeholder-agent

relationship. Furthermore, from the perspective of stakeholder theory, there is another type of

opportunistic behaviors: inappropriately meet the demand of one stakeholder at the cost of the

other (hereafter, we label it as “unethical tradeoff”). Recall Mitchell et al.’s (1997) three key

criteria for allocation of resources among stakeholders: legitimacy, power, and urgency. When

making tradeoff among stakeholders’ interests, managers need to make an ethical decision based

upon the three key criteria. However, as noted by Mitchell et al. (1997), managers often place a

high priority on power, thus stakeholders lacking power are neglected or given a low priority. As

mentioned earlier, the customers for an auditee’s products are considered a stakeholder of the

registrar. Most of theses customers fall into the category of Mitchell et al.’s (1997) discretionary

stakeholders, which possess the attribute of legitimacy, but have no power to influence an

organization and have no urgent claims. Thus, the auditee’s customers are very likely to be

neglected by the registrar, and the registrar may scarify their interest to retain clients (auditees).

There is one exception, though. Some industrial buyers demand that auditing be done by a

designated, reputable registrar (Yeung and Mok, 2005), or even hire an auditor by themselves.

These customers are often large multinational corporations, which have strong power over

industrial suppliers (auditees). In this case, the registrars are less likely to relax their requirements

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for the auditees.

Thus, in the triangle relationship, the registrar may act opportunistically in two ways. First,

the registrar does not make sincere effort to accurately evaluate the auditee’s performance, which

leads to the certification of unqualified firms. Such behavior could constitute a “moral hazard”

problem, if the primary goal of the auditee is to improve its quality management system. The

reason is that by offering an “easy certification”, the registrar reduces its own workload in

assisting the auditee. Such opportunistic behavior could also be regarded as an “unethical

tradeoff” problem, if the auditee demands a quick certification and the registrar deliberately

relaxes its standard to meet such a demand. As a result, the registrar satisfies the auditee at the

expense of the buyer’s interest. Second, the registrar does not make sincere effort to effectively

assist the auditee in improving its quality management system, which constitutes a “moral

hazard” problem. Finally, the registrar may sell unnecessary training programs to their clients. In

this case, the registrar misrepresents the effectiveness of its training program. This constitutes an

“adverse selection” problem.

Similarly, the auditee may act opportunistically. Even though the auditee does not faithfully

comply with ISO 9001 standards, it may manage to obtain the certification by cheating the

auditor. This is considered an “unethical tradeoff”, since the behaviors benefit the stockholder of

the auditee at the expense of the customer and/or the registrar (the registrar’s reputation is at risk).

RESEARCH PROPOSITIONS

We are interested in the sources and control mechanisms of the opportunism in the context of

the principal-agent-stakeholder triangle, and the effects of the opportunism on the exchange

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outcomes in the triangle. We first draw upon agency and stakeholder theories to identify the

motivation and deterrent of opportunism in the triangle. We focus on two aspects of the triangle

relationship: (1) the principal-agent relationship between auditee and registrar; and (2) the effects

of stakeholders (customers) influence on the opportunistic behaviors in the principal-agent

relationship.

In the principal-agent relationship between auditee and registrar, we classify the factors

affecting opportunistic behaviors into four groups: (1) norms of conspiracy, which facilitate

“collaboration” between the registrar and the auditee to conduct a quick and easy certification

process; (2) goal congruence and incongruence. Agency theory maintains that goal incongruence

creates motivation for opportunistic behaviors. However, in a triangle relationship, goal

congruence between two parties such as principal and agent, but not with a third party such as

stakeholders, may result in opportunistic behaviors; (3) nature of exchange, which could either

foster or deter opportunism. This group consists of information asymmetry and dependence. As

we will discuss later, information asymmetry and dependence eventually lead to power. The more

powerful party is capable of acting opportunistically. On the other hand, the power they possess

also serves as a deterrent to opportunism of the other parties. Importantly, these factors does not

necessarily motivate firms to act or do not act opportunistically. They just provide or reduce

opportunities for one party to act opportunistically; and (4) design of contract, which reduce the

opportunism.

Norms of conspiracy

The aforementioned auditee’s and the registrar’s opportunistic behaviors could be their own

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unilateral actions. However, opportunistic behaviors also likely result from their “collaboration”

in a quick and easy certification process. While explicit conspiracy between the auditee and the

registrar could be rare, implicit conspiracy is often likely to occur. For example, the auditee may

buy unnecessary training programs from the registrar, with the implicit and mutual understanding

that it also “buys the certification” by doing so. Therefore, if the registrar does not thoroughly

evaluate the auditee’s performance, it constitutes either a “moral hazard” problem (unilateral

action), or an “unethical tradeoff” problem” (bilateral, implicit conspiracy).

The distinction between unilateral and bilateral opportunistic behaviors lies in whether there

is a conspiracy between the auditee and the registrar. The conspiracy is almost impossible to

become a formal one with a written agreement. Rather, it is more likely to be an implicit,

unspoken mutual expectation, or at most, oral agreement. Therefore, in this study, we concentrate

on the issue of whether such a mutual expectation, or norms of conspiracy, exists between the two

parties.

Norms are the expectations about behaviors that are at least partially shared by a group of

decision makers (Heide and John, 1992). Macneil (1980) has interpreted the concept of norms in

two ways: (1) those that contain expectations about an individualistic or competitive interaction

between the individual parties; and (2) those that are based on the expectations of mutual

interests. Between the two types of norms, the latter is essentially prescribing stewardship

behaviors and is designed to enhance the well-being of a relationship as a whole (Macneil, 1980).

Such “cooperative norms” have been widely studied in prior studies (Cai and Yang, 2008;

Cannon et al., 2000; Heide and John, 1992). The norms of conspiracy could be positioned

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somewhere between the two types of norms. Such norms lead to individualistic but collaborative

behaviors conducted by the auditee and the registrar altogether, which constitute an “unethical

tradeoff” problem in the context of their relationships with the auditee’s customer as a

stakeholder. That is, the two parties collaborate with each other to obtain mutual interest at the

cost of a third party (the auditee’s buyer). We argue that norms of conspiracy will increase

opportunistic behaviors on the parts of both the auditee and the registrar.

Proposition1a: norms of conspiracy are positively related to the auditee’s opportunistic behaviors.Proposition 1b: norms of conspiracy are positively related to the registrar’s opportunistic behaviors.Goal congruence and incongruence

Goal incongruence is embedded in most principal-agent relationships. For ISO 9001

certification, the auditee is the focal party, and thus its goals for the certification set the tune for

the triangle relationship. There are various reasons for a firm to adopt ISO 9001, which could be

broadly classified into two categories: (1) external pressure, such as government regulations,

buyer demand, and competitors’ actions; and (2) internal needs to improve quality management

practices (Anderson et al., 1999; Brown et al., 1998; Huarng et al., 1999; Naira and Prajogo,

2009). Theoretically, these two types of goals are not contradicting each other. However, in

practice, firms mainly driven by the internal needs tend to implement the quality system

faithfully. It is reported that firms, which adopted ISO 9000 mainly because of external pressure,

are less likely to fully implement the standard-compliant system, thereby gaining less benefit than

those adopting the standard mainly for quality improvement purposes (Leung et al., 1999;

Prajogo, 2011). Accordingly, we maintain that, a firm is more likely to act opportunistically (i.e.,

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focusing more on obtaining the certification itself than on implementing the quality system), if its

adoption of the standard is mainly motivated by the external pressures rather than the internal

needs.

Proposition 2a: auditee’s motivation to obtain certification to deal with external pressure is positively related to their opportunistic behaviorsProposition 2b: auditee’s motivation to obtain certification to improve internal operations and quality is negatively related to their opportunistic behaviors

Furthermore, a firm wants to improve its internal operations may proactively seek assistance

from the registrar in the implementing ISO 9000 standard. Such efforts can reduce the registrar’s

opportunistic behaviors. In contrast, a firm intends to obtain a certification to deal with external

pressure may not pay attention to the implementation of the ISO within organization. Thus, the

firm is unlikely to closely monitor the registrar’s behaviors, and demand the registrar to make

efforts in assisting ISO implementation. This can lead to registrar’s opportunistic behaviors.

Furthermore, norms of conspiracy are more likely to exist between the registrar and the auditee, if

the auditee only wants to use the certification to deal with external pressures. Thus,

Proposition 3a: auditee’s motivation to obtain certification to deal with external pressure is positively related to registrar’s opportunistic behaviorsProposition 3b: auditee’s motivation to obtain certification to improve internal operations and quality is negatively related to registrar’s opportunistic behaviors.Proposition 4a: auditee’s motivation to obtain certification to deal with external pressure is positively related to norms of opportunism.Proposition 4b: auditee’s motivation to obtain certification to improve internal operations and quality is negatively related to norms of opportunism.

Nature of exchange

Nature of exchange includes factors such as information asymmetry and dependence. First,

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information asymmetry occurs when the principal cannot accurately observe the agent’s behavior

or have difficulty to understand the knowledge utilized by the agent (Bhattacherjee, 1998). There

are two types of information involved here: knowledge and operations information. Knowledge

involves techniques, know-hows, and managerial skills. Asymmetry of such information creates

expert power, which exists if the source has access to knowledge, information, or skills desired by

the target (French and Raven, 2001; Maloni and Benton, 2000). Operations information involves

operation procedures, production and delivery schedules, and inventory levels. Asymmetry of

such information offers opportunities for a party to lie about its operations and capabilities.

The central issue of ISO 9001 certification is to review the auditee’s operational

information. If the auditee hides operational information from the registrar, it constitutes an

opportunistic behavior. We argue that knowledge asymmetry could affect such opportunistic

behavior: if the registrar does not have sufficient knowledge of the auditee’s industrial

characteristics and its operations, knowledge asymmetry occurs and the auditee has expert power.

It becomes easy for the auditee to disguise its operations procedure, and hide non-conformity

from the registrar, incurring operational information asymmetry (Boiral, 2003). On the other

hand, if the auditee does not possess sufficient knowledge of the ISO 9001 standard and quality

management practices, it becomes difficult for the auditee to judge whether the registrar is

making sincere efforts to assist it, and/or selling many unnecessary training programs. In this

case, the registrar has expert power and may act opportunistically. Therefore:

Proposition 5a. Between the auditee and the registrar, knowledge asymmetry of the auditee’s industry and operations is positively related to the auditee’s opportunistic behaviors.Proposition 5b. Between the auditee and the registrar, knowledge asymmetry of the ISO 9001

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standard is positively related to the registrar’s opportunistic behaviors.

Dependence between parties creates coercive and reward power. That is, the less

dependent party in a relationship has power over the more dependent party, since it hold more

value and scare resource desired by the other party (Ireland and Webb, 2007). Accordingly,

coercive power could be exercised by threating to withhold the resource, while reward power

could be exercised by promising to offer the resource (Cool and Henderson, 1998; Hu and Sheu,

2005; Ireland and Webb, 2007).

Essentially, in a business relationship, there are two sources of dependence: importance of

business and availability of alternatives (Cai and Yang, 2008; Cool and Henderson, 1998;

Handfield, 1993). In the relationship between the auditee and the registrar firm, if the auditee is a

large firm, which can spend a large amount of money on the training and certification, it becomes

an important customer for the registrar firm. In this case, moral hazard would be reduced since

the registrar is likely to make substantial effort to assist the auditee in improving its quality

management system. But the unethical tradeoff risk also increases, since (1) the registrar may

wish to sell more training programs to a rich client; and (2) the registrar is more likely to bend to

the demand of the client by issuing an “easy certification”. In other words, the dependence may

lead to norms of opportunism. Therefore,

Proposition 6a: The registrar’s high dependence on the auditee is negatively associated with the registrar’s opportunistic behavior of moral hazards (registrar’s assistance).Proposition 6b: The registrar’s high dependence on the auditee is positively associated with the norms of opportunism.Design of contract

We maintain that design of contract could deter opportunism in principal-agent relationship.

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Essentially, contract between firms establish legitimacy, which is a desirable social good, defined

by legal systems or social traditions (Benton and Maloni, 2005; Maloni and Benton, 2000;

Mitchell et al., 1997). Between the principal and agent, legitimacy is mostly a result of legal

contract between them. To what extent the parties have legal claims over the other, however, is

determined by the contract design. For example, a contract with detailed, specific terms of the

registrar’s responsibility enables the auditee to request more assistance from the registrar than one

with ambiguous terms. In other words, a well-designed contract establishes strong legal legitimacy

for a party.

Agency theory suggests that the principal and the agent have different risk preference,

which affects their preference for contracts. The classic agency theory assumes that, in the

context of corporate governance, the principals (stockholders) are risk neutral because they are

able to diversify their investment, whereas the agents (employees) are risk-averse because they

cannot diversify their employment (Fontrodona and Sison, 2006; Wright et al., 2001). In other

words, the principal is less dependent on the relationship than the agent and thus the former is

less risk-averse than the latter. The risk preference affects their contract preference: the risk

aversion party usually prefers an outcome-based contract over a behavioral-based contract

(Bhattacherjee, 1998). As such, the less dependent party in a relationship may prefer a behavior-

based contract, while the more dependent party may prefer an outcome-based contract.

Between the auditee and the registrar, the risk preference issue is more complex. It is

difficult, for the auditee, as a principal, to diversify in terms of ISO 9001 certification—once they

sign the contract, they have to stick to the specific registrar for three years. In this sense, they are

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in a similar situation to the agents in the classic agency theory. Thus, the auditee is likely to

become risk-averse. In contrast, the registrar usually has many clients, thus they can diversify

their business across these clients. Thus, we argue that the registrar is risk-neutral. Therefore, the

logic of the classic agency theory implies that the auditee’s primary choice is to include a well-

designed outcome-based incentive pay plan in the contract, thereby aligning the interest between

the principal and the agent (Bloom and Milkovich, 1998). However, a direct incentive payment is

difficult to implement between the registrar and the auditee: No registrar will guarantee in a

contract that the certificate will be issued. Thus, from the auditee’s perspective, the best way is to

define the appropriate behaviors of the registrar in a formal contract, in which the types of

information and assistance the registrar will provide during the process of auditing and the

process of correcting nonconformity is defined. Yet, to what extent an auditee is able to draft a

successful behavior-based contract depends the auditee’s knowledge of ISO 9001. Thus:

Proposition 7a: the knowledge asymmetry between the auditee and the registrar regarding the ISO 9001 standard is negatively related to the specificity of the behavioral-based contract between the two parties.

Proposition 7b：The specificity of the behavioral-based contract is negatively associated with the

registrar’s opportunistic behaviors.

The influence of stakeholder

The stakeholder power originates from mutual dependence between stakeholders and a

firm (Frooman, 1999). If one customer or a group of customers constitute a large portion of the

auditee’s business, and/or the auditee has difficulty in finding alternative customers, the auditee is

dependent on the customer (s). Importantly, there are two kinds of customer demands for ISO

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certification : (1) Customer directly demand the auditee to be certified; (2) customers do not

directly demand the auditee to be certified, but they will make purchasing decision based upon

the certification. The firm’s dependence on the both types of customers will affect their

opportunistic behaviors.

While firms’ dependence on the customers creates customer power, it does not

necessarily prevent opportunistic behaviors unless customers are able to exercise the power to

monitor/punish the opportunistic behaviors. Recall that stakeholders are able to influence a firm

in four ways: (1) direct withholding, where stakeholders decide not to allocate their resources to a

firm; (2) direct usage, where stakeholders continue to supply resources to a firm, but with

conditions attached; (3) indirect withholding, where stakeholders work with an ally, which stops

allocating its resources to a firm; and (4) indirect usage, where stakeholders work with an ally,

which supplies resources to a firm, but with conditions attached (Frooman, 1999). The first two

choices are used when stakeholders have power over the firm. Since customers are able to

influence firm by their own actions, such as purchase or not to purchase product/service, we

maintain that they are mostly likely to exercise their power by using direct withholding or direct

usage. Importantly, direct withdrawing could be utilized by all customers, while direct usage is

mostly utilized by industrial buyers.

For an auditee engaging in opportunistic behaviors, the primary concern related to

customer is the extent to which the opportunistic behaviors are likely to result in direct

withdrawing, i.e., to what extent such behaviors result in loss of business. Customers do not need

to actually exercise such power. The firm is unlikely to conduct opportunistic behaviors if they

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expect that the risks of customer direct withdrawing is high. Therefore:

Proposition 8a. The auditee’s perception of customer direct withdrawing risks is negatively related to their opportunistic behaviors.

Additionally, industrial buyers could also utilize direct usage strategy. Specifically, a buyer

may attach a condition to purchase agreement that it will monitor the supplier’s operation. An

auditee is unlikely to act opportunistically if being closely monitored by customer(s). Monitoring

may take the forms of site visit and/or information exchange. We expect that:

Proposition 8b: The customers’ monitoring is negatively related to the auditee’s opportunistic behaviors.

Exchange outcomes of certification

As mentioned earlier, the classic agency theory suggests an efficient market: the

principal and the agent have freedom of entering and exiting from the market. However, Hill and

Jones (1992) argue that due to frictions in a market, disequilibrium conditions in the market may

persist for a prolonged period of time before an efficient equilibrium is re-established.

We consider such disequilibrium conditions in the triangle relationship. If we assume an

efficient market, the opportunistic behaviors will be punished by the market. But such efficient

market outcomes are difficult to achieve in the real world. Hill and Jones (1992) suggest that in

the market adjustment process, frictions, such as barriers to entry and exit, and organizational

inertia may slow down the process. Additionally, we maintain that information asymmetry could

serve as a third friction hindering the process.

There are three types of exit that could punish opportunistic behaviors in ISO 9001

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certification: (1) the auditee exists its relationship with registrar; (2) the customers exist its

relationship with the auditee; and (3) the customers refuse to recognize a certification issued by

the registrar. The last one is rare. Thus, we focus on the first two situations.

The contract between an auditee and its registrar usually lasts 3 years. This creates difficult

for both parties to exit in the short term. After the contract expires, the auditee can switch

registrars. In an efficient market, if the registrar acts opportunistically, the auditee may switch.

And the business community may eventually recognize that the certification from this particular

registrar is not trustful. The registrar will thus lose business. However, in reality, even if the

auditee is dissatisfied with the registrar, the Hill and Jones’ (1992) two frictions may deter the

auditee from exiting. Regarding the barrier of exit, there is a cost associated with switching

registrars. An alternative registrar could be more expensive. The searching process could be time

consuming and costly. There is an additional risk associated with switching: there is no guarantee

that the new registrar could perform better than the current one. If a firm lacks the resources to

pay for the cost and the ability to identify an exact problem with the current registrar (knowledge

asymmetry ), and has difficulty drafting a behavior-based contract, it could result in inertia—

firms are reluctant to correct disadvantage due to the lack of ability (Hill and Jones, 1992).

Thus, the registrar’s opportunism will affect auditee’s commitment in two ways. If the

auditee intends to improve its internal operations through adoption of ISO 9001, the registrar’s

opportunistic behaviors should reduce its commitment. However, the negative effect is moderated

by knowledge asymmetry between them. The large the asymmetry is, the less likely the auditee

will switch. In contrast, if the auditee’s main objective for adopting ISO 9001 is to deal with

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external pressure, it is likely that the registrar’s opportunistic behaviors are what it desires. Thus,

Proposition 9a: registrar’s opportunistic behavior is negatively related to the auditee’s commitment to the relationship if the auditee adopts ISO 9001 mainly to improve its internal operations. The relationship is negatively moderated by knowledge asymmetry between auditee and registrar.Proposition 9b: registrar’s opportunistic behavior is positively related to the auditee’s commitment to the relationship, if the auditee adopts ISO 9001 mainly to deal with external pressure.

Between the auditee and its customers, in an efficient market, if the auditee acts

opportunistically in the certification process, the customer will eventually recognize that its

quality system does not meet the requirements of ISO 9001. Thus, the auditee will lose its market

share. But as in the previous case, frictions may exist in this case. If the auditee acts

opportunistically, and does not totally meets the requirements of ISO 9001, there could be

operations-related dispute between it and its customers and/or distributors. However, the dispute

may have relatively small impact on auditee’s business initially. The customers and distributors

may ignore or tolerate operations problems if the problems are minor. When the problem

becomes more severe, it is more likely the customers will switch to other suppliers and/or

distributors may drop the product. Consequently, the auditee loses market share. Thus, we expect

a curvilinear relationship between operational disputes and auditee’s financial and market

performance.

We propose that:

Proposition 11: the auditee’s opportunistic behaviors will increase operations-related disputes. Proposition 12: operations-related dispute level relates negatively to the auditee’s market performance, but the marginal effects of such dispute increases as the dispute level increases.

Conclusion

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In this paper, we maintain that while a firm serving an industrial customer, its performance

can affect the customer’s stakeholders as well as the customer itself. Particularly, during the ISO

9001 certification process, both the registrar firm and auditee could act opportunistically. We

identify various factors that may lead to the opportunistic behaviors and affect the auditee’s

business performance. In a worst scenario, the auditee and registrar may involve in a joint, but

often implicit conspiracy, which allows the auditee to obtain certification easily and the registrar

to retain the client. While such behaviors may hurt the stakeholders’ interest, the market may not

be able to quickly respond and punish the opportunistic behaviors. Even if the market eventually

punishes the opportunistic parties, the costs for society could be substantial, as in the case of the

2008 financial crisis. While the opportunistic behaviors in the ISO9001 process may not result in

as much damage as those conducted by CRA and their clients, it is also important to note that ISO

9001 registrars are much less closely scrutinized by government agencies, compared to CRA.

Furthermore, the fact that ISO 9001 criteria are only general principals leaves substantial rooms

for registrars to interpret the criteria. Thus, it is also much easier to act opportunistically in the

ISO 9001 certification process. As argued, market mechanism is insufficient in monitoring and

punishing such opportunistic behaviors. Thus, Country accrediting agencies need to do a better

job in governing the certification process. In countries such as Canada, the country accrediting

agencies do not even have a complete list of firms certified for ISO 9001, and thus is impossible

for them to closely monitor the certification outcomes. We maintain that the country accrediting

agencies need to review, at least, some of the certification outcomes and revoke certificate if

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major discrepancies are found in the auditee firms. Furthermore, we recommend that, various

industrial associations develop more detailed evaluation criteria for their industries, based upon

the ISO 9001. For example, automobile industry has developed QS 9000 to address the particular

quality requirement in the industry. Such industry-specific, detailed standards could greatly reduce the

room for opportunistic behaviors.

Figure 1. principal –agent-stakeholder triangle from the auditee’s perspective

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