Opportunistic Disclosure in the Inter-Organizational Relationships

Abstract

A contract governs a trade between a buyer and a supplier. This contract specifies: (i) a cost reimbursement and (ii) a profit sharing arrangement of the inter-organizational relationship. We examine, the role the accounting system choice has on the efficiency of the IOR when the supplier can disclose accounting information opportunistically. The supplier's opportunism is rooted in his superior knowledge about the production and thus cost function. The supplier can manages the rate that is used for allocating overhead costs to the reimbursed product. Two methods of allocation rate management are available, leading to two distinct inefficiencies. First, the supplier can use some input factors in excess (Real Cost Management). Second, the supplier can influence the trade quantity (Real Activity Management).This paper finds that even with opportunistic disclosure, the total profit of the relationship exceeds the profit under the arm's-length relationship. With a traditional accounting system, the supplier engages in Real Cost Management if the total overhead cost is high compared to the total direct labor cost. With an Activity-Based Accounting system, the supplier engages in Real Cost Management when the overhead cost of the traded product is small compared to the overhead cost of other products. Therefore the choice of accounting system can have a profound impact on the efficiency of an IOR.This paper further show that the supplier engage in Real Activity Management regardless of the accounting system in place. However, the size and the direction of the quantity distortion depend on the accounting system. This further strengthens the conclusion, that the choice of accounting system affects the efficiency of the IOR, because it affects the supplier opportunism despite the control system (the contract) in place.