Risk Sharing in Supplier Relations: An Agency Model for the Italian Air Conditioning Industry

We apply agency theory to model vertical inter-firm relationships and study risk sharing between manufacturers and first-tier suppliers in the Italian high-precision air conditioning (AC) industry. We explore to what extent buyers and suppliers share risk, and how suppliers’ financial, structural and technological characteristics, used as proxies for environmental uncertainty, moral hazard and risk aversion, are related to the degree of risk-sharing. Improving the modeling techniques used in previous, similar studies, we use regression analysis to test the agency model on the supplier networks (respectively of 50 and 58 suppliers) of two leading Italian highprecision AC manufacturers. The regression analysis shows that both the manufacturers absorb risk to a nonnegligible degree, and supports the hypotheses that they absorb more risk a) the bigger are the fluctuations in the supplier’s costs; b) the more risk averse is the supplier; and c) the less severe is the supplier’s moral hazard. We interpret these findings and draw some managerial implications about the design of supply contracts, the optimal allocation of risk across supply chains and the management of supply networks.