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Outsourcing of Accounting Tasks in SMEs: An extended TCE Model

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 FACULTEIT ECONOMIE
EN BEDRIJFSKUNDE

HOVENIERSBERG 24
B-9000 GENT
Tel. : 32 - (0)9 – 264.34.61
Fax. : 32 - (0)9 – 264.35.92

WORKING PAPER

Outsourcing of Accounting Tasks in SMEs:

An extended TCE Model

Patricia Everaert 1
Gerrit Sarens 2
Jan Rommel 3

September 2006
2006/409

1
Ghent University, Department of Accounting and Corporate Finance, Kuiperskaai 55/E, 9000 Gent, Belgium;
Phone: 32 9 264 35 00, Fax: 32 9 264 35 88, email: Patricia.Everaert@UGent.be.
2
Ghent University, Department of Accounting and Corporate Finance, Kuiperskaai 55/E, 9000 Gent, Belgium;
Phone: 32 9 264 35 66, Fax: 32 9 264 35 88, email: Gerrit.Sarens@UGent.be.
3
Ghent University, Department of Accounting and Corporate Finance, Kuiperskaai 55/E, 9000 Gent, Belgium;
Phone: 32 9 264 35 41, Fax: 32 9 264 35 88, email: Jan.Rommel@UGent.be.

D/2006/7012/54 1
 Abstract

This study explores why small and medium-sized companies (SMEs) engage in outsourcing of accounting
services. We expand the transaction cost economics model by adding the variable resource deficit from
resource-based theory, while controlling for personal characteristics of the SME executive (age,
education), organizational structure, firm maturity and ownership structure.
We find that resource deficit, asset specificity and frequency are the most significant drivers of
outsourcing intensity with respect to accounting. Furthermore, the educational background of the CEO
seems to play an important role, as well as the presence of a separate CFO function within the firm.

Key words: outsourcing, accounting, SME, transaction-cost theory, resource-based theory

2
 Introduction

Outsourcing can be defined as the act of subcontracting out all or parts of a function in a firm to an

external party. Researchers increasingly are interested in outsourcing in specific functional areas, such as

information systems (Lacity and Willcocks, 1998) and human resource management (Gilley et al., 2004a).

As far as we know, however, research on the outsourcing of accounting services is missing. Furthermore,

Gilley et al. (2004b) has conducted research on the outsourcing of manufacturing tasks by small firms,

and has called for a more general theory of outsourcing, which would require the consideration of a

number of personal and organizational drivers.

The purpose of the current study has been to identify why some small firms become involved in the

outsourcing of accounting services, whereas similar firms perform the same tasks within the company.

Several prior models have been proposed to explain outsourcing. Transaction cost theory (TCT) is the

most widely used framework for both large and small firms, including drivers such as asset specificity,

environmental uncertainty, behavioral uncertainty and frequency (see Murray and Kotabe, 1999; Leiblein

and Miller, 2003; Brouthers and Nakos, 2004). Recently, the TCT framework has been extended by

adding personal characteristics, such as top management’s risk aversion and top management’s trust in its

service provider (Brouthers and Brouthers, 2003; Gilley et al., 2004b). This trend is in line with the upper

echelon theory, suggesting that outsourcing decisions in SMEs may be influenced significantly by the

personal characteristics of the SME executive (Hambrick and Mason, 1984; Hitt and Tyler, 1991;

Wiersema and Bantel, 1992). Other researchers have adopted a resource-based view to explain

outsourcing (Barney et al., 2001; Leiblein, 2005). Companies outsource because they have a resource

deficit; i.e. they do not possess the resources or expertise necessary to perform certain essential tasks. This

is particularly relevant for SMEs, since they face more resource constraints than larger firms, purely

because of their smaller size (Marriott and Marriott, 2000; Brush et al., 2001). Hence, this study

embellishes the extended TCT framework by adding resource deficit as a new explanatory variable.

3
Furthermore, Gilley et al. (2004b) suggest that managerial factors, as well as organizational factors, may

have an important impact on the outsourcing decisions of small firms. They suggest that factors like the

age and educational background of the CEO, as well as the organizational and ownership structure of the

firm and the firm’s maturity might influence the decision to outsource. Hence, we include these five

variables as control variables in the extended TCT model.

In this study (the first to examine accounting in a SME context) we attempt to expand the body of

knowledge about outsourcing in three ways. First, we provide theoretically-derived hypotheses in an

attempt to explain why SMEs are outsourcing accounting tasks. Thus, we conform to the trends identified

by Gilley et al. (2004a), in that we focus, in depth, on one functional area, in particular on accounting.

Second, we test these hypotheses using an extended TCT-based model of outsourcing. This TCT model

includes asset specificity, environmental uncertainty, behavioral uncertainty and frequency, and earlier

had been appended with trust and risk aversion (Brouthers and Brouthers, 2003; Gilley et al., 2004b). It

now is extended further by adding resource deficit as a variable (Barney et al., 2001). Transaction cost

theory and the resource-based view are not entirely mutually exclusive, making it hard to separate them,

as they may overlap in some of the predictions. Third, we include four new control variables, educational

background, age of the CEO, ownership structure, and the presence of a CFO as a separate function.

Scholars such as Park and Krishnan (2001) and Gilley et al. (2004b) suggest that these variables may have

an impact on outsourcing decisions. The results show, indeed, that frequency, asset specificity, resource

deficit, educational background of the CEO, and the existence of a separate CFO function are significant

drivers to explain the outsourcing of accounting services.

In the following section, we develop several hypotheses. This is followed by a description of the

methodology utilized in the current survey. Next, the findings are presented and contrasted with the

literature, and implications are drawn. Finally, implications for future research are discussed.

4
 Literature and Hypotheses

Outsourcing Intensity

In this paper, we refer to both the external accountant and the accounting firm as the ‘external

accountant’, as we address the process of outsourcing. Conversely, we refer to the ‘internal accountant’

as that company employee performing the accounting tasks within the SME, thereby addressing the

process of internalising. As indicated in Figure 1, the annual accounting process in a company can be

divided into six well-defined tasks: (1) entry of invoices and financial transactions; (2) preparation of an

interim profit and loss account (e.g. monthly profit calculation); (3) period end accounting (e.g.

depreciations, interest accruals); (4) preparation of financial statements (balance sheets, profit and loss

account, notes); (5) Belgian Value Added Tax (VAT) compliance; and (6) Belgian corporate income tax

compliance. These activities represent the basic accounting tasks that are needed to fulfil the legal

requirements pertaining to the publishing of financial statements and the filing of VAT and income taxes.

Additional accounting tasks (e.g. business advice to managers) have been excluded from this study, since

these activities happen on an ad hoc basis and significantly differ in terms of content between different

small firms (Gooderham et al., 2004).

[Insert Figure 1]

During the preliminary interviews, it became clear that considering the basic accounting process simply in

terms of outsourcing or internalising does not capture reality. First, many SMEs perform some of the six

accounting tasks internally, while they outsource certain other accounting tasks. Secondly, companies use

a mix of outsourcing and internalising, even within a single task. For instance, an internal accountant

frequently prepares the period-end accounting, while the review of this task is outsourced to an external

accountant. Hence, following the lead of Gilley and Rasheed (2000), we need to combine the breadth and

depth of outsourcing. Breadth is defined as the number of accounting activities outsourced (as a

5
percentage of all accounting tasks). Depth is defined as the average degree of outsourcing for all

outsourced tasks( again expressed as a percentage). Breadth and depth are multiplied to form a single

indicator of the overall degree of outsourcing, the so-called outsourcing intensity. This reflects the firm’s

overall reliance on outsourcing, as a percentage, for basic accounting services.

Explanatory Variables from Transaction Cost Theory (TCT)

Transaction cost theory (TCT) has been the predominant framework employed to investigate the

determinants of outsourcing in manufacturing (e.g. Masten, 1984; Walker and Weber, 1984). In general,

the decision to outsource or internalise in a given situation depends upon comparative transaction costs;

that is, the costs of running the service, including the ex-ante costs of negotiating a contract and the ex-

post costs of monitoring performance and providing feedback (Williamson, 1985). Outsourcing is

favoured in situations in which markets are competitive (i.e. many potential suppliers). Market pressures

minimize the need for monitoring supplier behaviour (Hennart, 1989). When markets fail and the range of

suppliers available to a firm is restricted, the supplier has a tendency to behave opportunistically. This

opportunistic behaviour only can be reduced through stringent negotiation and extensive supervision of

contractual relationships, thereby greatly increasing transaction costs (Dwyer and Oh, 1988). In such

circumstances, the firm can reduce its transaction costs significantly by replacing external suppliers with

its own employees, whose behaviour can be monitored and controlled more effectively (Hennart, 1989).

Asset Specificity

The most important reason for market failure is the presence of specific assets (Williamson, 1985; 1986;

Klein et al., 1990). In general, specific assets are defined as human assets, physical assets, and company

specific routines not re-deployable to alternative uses. When investments in these kinds of asset are made,

a supplier and a buyer are ‘locked into’ a transaction, because the assets are specialized to that transaction

6
and have limited or no value outside that transaction (Williamson, 1985). Specific assets make it costly to

switch to a new relationship, because the market safeguard against opportunism (sourcing from another

supplier) no longer is effective (John and Weitz, 1988). The core proposition of transaction-cost theory

asserts that specialized assets have lower transaction costs within the firm, because the company has more

powerful control and monitoring mechanisms available, because of its ability to measure and reward

behavior (Eisenhardt, 1989). Hence, with asset specificity, firms would rather internalize than outsource.

Contrary to manufacturing activities, services like accounting tasks tend to be less capital-intensive and

more people-intensive (Erramilli and Rao, 1993; Brouthers and Brouthers, 2003). The added value for the

company tends to be derived from idiosyncratic assets, such as company-specific accounting software,

high-level professional skills, and the talents of employees, as well as the employees’ (intangible)

specialized knowledge of the specific characteristics of the company and its activities (Anderson and

Gatignon, 1986; Hennart, 1988; Erramilli and Rao, 1993; Murray and Kotabe, 1999). Also, investments in

training can be considered to be important idiosyncratic assets (Contractor and Kundi, 1998). In

accordance with Erramilli and Rao (1993), we expect that the decision to outsource will vary with the

degree of idiosyncratic asset investment. In other words, as the accounting activities become more

customized and specialized, because of a high level of idiosyncratic asset investments, asset specificity

increases and, consequently, transferring these activities to an external accountant can be protracted,

difficult, costly and incomplete. Moreover, transactions of this kind pose a greater risk to the company, if

the external accountant does not deliver the accounting activities according to specifications, or if he fails

to rend the activities on time, because alternative sources of supply either are limited or unavailable

(Murray and Kotabe, 1999). This leads to the following basic hypothesis:

H1: The higher the asset specificity of accounting tasks, the less intensively they are outsourced.

7
Environmental Uncertainty

Environmental uncertainty refers to “the expected variation in the demand for activities” (Widener and

Selto, 1999; 48). Translated to the specific context of this study, environmental uncertainty is about the

stability and predictability of the workload related to basic accounting activities, as a consequence of the

volatility of business activities. If business activity is volatile (e.g., unstable purchases and sales because

of seasonal trends, merges, acquisitions or plant closures), the number of invoices to process will be less

predictable as well. As all activities in the accounting process are inter-connected, the workload related to

the sequential accounting tasks also becomes unstable and unpredictable.

If companies can predict and schedule the workload related to their accounting activities accurately, the

costs of contracting should be low, and firms may outsource their accounting activities, while accruing

low transactions costs. Conversely, it can be argued that low predictability of the workload related to

accounting activities creates high transaction costs, because contractual agreements with an external

accountant may need to be renegotiated and changed (‘spot contracting’) (Williamson, 1991). This

requires time that the SME may not have, and reduces the flexibility needed to address these fluctuations

in the workload in a timely fashion (Erramilli and Rao, 1993). Moreover, a high level of uncertainty

makes it extremely costly to write and enforce a contract, with an external accountant, which specifies all

possible future conditions. Hence, when the workload of the accounting activities is less stable and

predictable, an internal accountant will be able to respond more quickly to these fluctuations (Williamson,

1991; Hennart, 1994), which compensates for the uncertainty (Klein et al., 1990).

H2: The higher the environmental uncertainty on accounting tasks, the less intensely they are

outsourced.

Behavioural Uncertainty

Behavioural uncertainty reflects difficulties in monitoring performance and controlling the human

tendency toward opportunism, which can involve cheating, distortion of information, shirking of

8
responsibilities, and other forms of dishonest behaviour (Williamson, 1985; Hill, 1990). Here, behavioural

uncertainty can be translated as the difficulty in evaluating whether the accountant (internal or external)

did his or her job accurately and to the best of his or her ability. High behavioural uncertainty causes high

transaction costs, due to writing, negotiating, monitoring, and enforcing contracts, all done to control for

opportunistic behaviour. As a result, when contributions from an outside supplier cannot be assessed

accurately, adequate contracts with external suppliers will be costly to draft. In this case, it is more

efficient to internalize the service, which gives the firm a legal right to control the actions of its employees

directly (Williamson, 1985; Klein et al., 1990). Hence, if it is difficult to evaluate an accountant, then TCT

predicts that the accounting tasks will not be outsourced, as the SME prefers to control the performance of

the accountant directly.

H3: The higher the behavioural uncertainty on accounting tasks, the less intensely they are

outsourced.

Frequency

Transaction frequency is the frequency with which transactions recur (Murray, 2001). Frequent or

recurrent activities can create the benefits of economies of scale, which permit the recovery of setup costs

(Widener and Selto, 1999). Therefore, TCT predicts that frequent or recurrent services are more likely to

be produced internally (Williamson, 1985). Frequency of accounting tasks can be understood in two ways.

On one hand, frequency can be understood as the periodicity of the accounting task. For instance, entry of

invoices can be done daily, weekly, monthly, quarterly, semi-annually or yearly. Accounting laws require

preparing financial statements once each year, but many accountants prepare financial statements more

often than this (e.g., monthly, quarterly or semi-annually). On the other hand, frequency also can be

understood in terms of the size of the activity. In particular for invoice entry, the size of the activity is

important. A company that processes 10 invoices every week has a lower frequency of invoice entry than

a company that processes 1,000 invoices every week. The former company likely will be more attracted to

9
outsourcing than the latter. Also Widener and Selto (1999) used a combination of periodicity and size-

indicators in their translation of frequency to an audit context. This leads to the following hypothesis:

H4: The higher the frequency of accounting tasks, the less intensely they are outsourced.

Trust of the SME Executive in an External Accountant

Many researchers have emphasized the importance of trust in supplier-buyer relationships (Moorman et

al, 1992; Dyer and Chu, 2000). Bennet and Robson (1999) found that 83% of SMEs seek advice from

accountants, and explain this high figure by conjecturing that accountants probably are in a position of

high trust with their customers. We follow the lead of Zaheer et al. (1998) and define trust in the external

accountant as expectations that the accountant (1) can be relied upon to fulfil legal obligations; (2) will

behave in a predictable manner; and (3) will act and negotiate fairly when the possibility for opportunism

is present. This definition of trust includes expectations of reliability (“the accountant is competent”),

predictability (“the accountant will behave in a consistent way”) and fairness (”the accountant will charge

fairly for provided services”). Note that we consider trust at the individual level, i.e. trust between the

small business executive and the external accountant, thereby denying the inter-organizational trust

component (Zaheer et al., 1998). Following Bouthers and Bouthers (2003), we hypothesize that, if the

external accountant and the SME executive maintain a trustworthy relationship, opportunism will no

longer be of concern. This leads to the following hypothesis:

H5: The higher the level of trust of the SME executive in the external accountant, the more intensely

the accounting activities are outsourced.

Risk Aversion of the SME Executive

In accordance with Gilley et al. (2004b), examining the relationship between managerial risk aversion and

outsourcing may provide useful insights for SMEs. According to the manufacturing outsourcing literature,

an outsourcing contract may reduce the risks of a firm in at least three different ways (Gilley et al, 2004b).

10
First, an outsourcing agreement can divide the risks of business volatility between the two parties

participating in the agreement (Gilley et al., 2004b). Second, outsourcing allows clients to shift the risks

of technological obsolescence and updating onto their suppliers (Lever, 1997). Finally, outsourcing

requires a lower level of investment in capacity (Harrigan, 1984). Translating these findings to the

outsourcing of accounting, we expect that risk-averse SME managers will be more likely to engage in

outsourcing, because their investment in accounting employees and accounting software is reduced. In the

outsourcing situation, the external accountant will have to adopt the risk of keeping accounting knowledge

and software up-to-date. Consistent with Gilley et al. (2004b), we can assume that executives who are

relatively more risk averse will be more likely to outsource accounting tasks.

H6: The higher the level of risk aversion of the SME executive, the more intensely that accounting

activities are outsourced.

Resource Deficit from Resource-based Theory (RBT)

The resource-based view is more concerned with the lack of resources than the TCE-model (Madhok,

1996). The firm’s resource base is the primary source of competitive advantage (Grant, 1996). However,

this competitive advantage only is sustainable when the resources satisfy certain conditions. Barney (1991,

1995) argues that resources must be scarce, valuable, reasonably durable and socially complex.

Furthermore, the resource-based view focuses on resources that are costly-to-copy (Connor, 1991). In the

context of accounting, resources mainly refer to knowledge (see above). Grant (1996) distinguishes

explicit knowledge (‘knowing about’) and tacit knowledge (‘knowing how’). An example of explicit

knowledge in accounting is knowledge of generally-accepted accounting rules. However, applying those

rules in a given business environment also requires tacit knowledge. For accountants, tacit knowledge

primarily is acquired through practice, which makes it almost impossible to transfer (Kogut and Zander,

1992; Connor and Prahalad, 1996).

11
Resource-based theory states that the decision regarding which capabilities to maintain and develop in-

house is influenced by current knowledge of the firm and the expectation of economic gain from these

capabilities in the future (Kogut and Zander, 1996). If the firm has resource deficits, markets become

interested in filling the gap (Grant, 1996). In accounting, a resource deficit means that the company lacks

people or knowledge to fulfill the accounting tasks. The higher the resource deficit, the more attractive

outsourcing becomes (Dibbern and Heinzl, 2001). This is particularly relevant for SME’s, since resource

constraints generally are much more significant for SME’s than they are for large firms (Marriott and

Marriott, 2000; Brush et al., 2001). Their limited resources may lead them to very different strategic

choices, in comparison to larger firms (Erramilli and D’Souza, 1993). Therefore, we develop the

following hypothesis:

H7: The higher the deficit of a firm’s own resources and competencies related to accounting, the more

intensely the accounting activities will be outsourced.

Methodology

Data Collection

Survey Population

The target population (Van der Stede et al., 2005) includes all SMEs located in the Flemish part of

Belgium. Because of language differences between the Flemish and French-speaking parts of Belgium, we

selected only Flemish companies. We used the criteria of the European Commission (06/05/2003),

defining SMEs as companies employing fewer than 250 employees, while excluding micro-enterprises

(companies with fewer than 10 employees) because these companies hardly have any choice between

outsourcing and internalising. To generate a sampling frame representative of our survey population, we

used the CD-ROM Belfirst of Bureau Van Dijk, which contains 300,000 annual accounts of Belgian

companies, submitted in 2004. We excluded financial services and public companies, and included only

12
companies with limited liability, to make sure that all SMEs had to comply with the same statutory

requirements. This resulted in a survey population of 14,604 companies.

Sample Selection and Follow-up

Using a systematic probability method, a sample of 1,200 SMEs was generated randomly. A pre-

notification letter was sent by regular post mail. About 78 companies (6.5 per cent) agreed to participate.

In order to increase the response rate, and as suggested by Newby et al. (2003), we made additional phone

calls and sent out emails to initial non-respondents. These actions resulted in an additional 68 respondents.

In total, we received 135 surveys (response rate of 11.3 percent). When investigating these 135 surveys in

more detail, seven seemed unusable, because they did not fit within the SME definition used. Two

additional surveys had too much missing data to be considered useful. After excluding these nine, we

based our analysis on 126 usable surveys, which means an effective response rate of 10.5 per cent. This

response rate is just above the normally-low response rate of 5 to 10 percent expected for a postal survey

(see Alreck and Settle, 1985; Barnett, 1991) and is comparable to other studies focusing on SMEs (e.g.

Thong, 1999; Barrar et al., 2002; Daniel and Grimshaw, 2002). Using three ways to recruit respondents

does not appear to be a limitation of our study, because including a variable for collection method in our

regression models did not change any of the results [i].

Non-response Bias

To detect possible non-response bias, Armstrong and Overton (1977) suggest comparing key constructs

between early and late respondents. Our analysis revealed no significant differences between early and

late respondents, in terms of the number of employees or total assets (p = 0.49 for both measures).

Furthermore, none of the dependent or independent variables is significantly different between early and

late respondents. Including a dummy variable for late respondents into our regression models did not

change any of the results. The dummy variable itself was not significant (p = .22).

13
Variable Measures and Reliability

Table I reports the details of the measurement items and scales. Where available, we used existing

measurement instruments, but they were adapted to the context of accounting. The Cronbach’s Alpha

reliability value for each construct also is reported, as well as all factor loadings (Varimax rotation). All

items (after deleting two items for asset specificity and one item for environmental uncertainty)

significantly load on only one dimension, explaining 72 per cent of all variance.

[Insert Table I]

Dependent Variable: Outsourcing Intensity

Outsourcing intensity was measured in accordance with the method proposed by Gilley and Rasheed

(2000). For each task, participants were asked to indicate which percentage of the workload was

performed by the external accountant. The breadth of outsourcing was calculated as the number of tasks

that are (partly) outsourced. The depth of outsourcing measures the average degree of outsourcing and was

calculated as the average workload performed by the external accountant over all outsourced tasks. We

calculated outsourcing intensity by multiplying the breadth and depth of outsourcing, as illustrated in

Table II. Hence, outsourcing intensity is a continuous variable, ranging between 0 percent (no outsourcing

at all) and 100 percent (100 per cent outsourcing of all six tasks). Cronbach’s Alpha was 0.87 and found to

be consistent.

[Insert Table II]

14
Independent Variables

Asset specificity, environmental uncertainty and behavioural uncertainty were operationalized using items

from Poppo and Zenger (1998), Erramilli and Rao (1993) and John and Weitz (1988), all adapted to the

accounting context. Based upon factor loadings, some items were dropped; ultimately, Cronbach’s Alpha

ranged from 0.63 to 0.91. The low Cronbach’s Alpha for asset specificity can be explained by the fact that

this construct had to be adapted to the accounting context in a major way. Previous studies adapting this

construct to other specific contexts obtained similar reliabilities between 0.60 and 0.70 (Klein et al., 1990;

Erramilli and Rao, 1993; Brouthers and Brouthers, 2003). Frequency was measured by combining

periodicity measures with a volume measure. In accordance with Murray and Katobe (1999), we asked

respondents about the periodicity with which each of the six accounting tasks had been done over the last

year. The answering categories provided were: daily, weekly, monthly, quarterly, semi-annually and

yearly. The size of the transaction was measured as the total volume of invoices handled by the accountant

over the whole year. We used six categories, as this would be easier for respondents to fill out. For the

calculation of the overall frequency measure, we combined the periodicity measure of four tasks with the

size measure. We excluded the periodicity measure for VAT and income tax compliance, since these are

legally-determined and SMEs cannot influence this. The Cronbach’s Alpha of this newly-developed

construct was 0.63, which is quite reasonable when compared with previous studies constructing new

transaction cost measures (Murray and Kotabe, 1999; Brouthers and Naxos, 2004).

The measurement of trust of the SME executive in the external accountant was based on work by Zaheer

et al. (1998), but largely adapted to accounting. Similar to Moorman et al. (1992), we added a fourth item,

asking directly about the trust relationship of the SME executive and the external accountant. Cronbach’s

Alpha for this measure was 0.89. Risk aversion was measured based upon two items proposed by Miller

and Friesen (1982) and was found to be consistent (Cronbach’s Alpha = 0.85). Resource deficit was

measured as per Dibbern and Heinzl (2001) and found to be consistent (Cronbach’s Alpha = 0.86).

15
Control Variables

We also included eight control variables: total assets, industry, the existence of a separate CFO function,

age of the CEO, educational background of the CEO (university degree as well as economic-orientation),

firm maturity (firm age), and family ownership.

First, the ’upper echelons’ perspective, espoused by Hambrick and Mason (1984), suggests that certain

characteristics of executives affect their choice of strategies (Hitt and Tyler, 1991; Wiersema and Bantel,

1992). Park and Krishnan (2001) found that, when SMEs select suppliers, the age, and the level and field

of education of the SME executive has a significant impact upon the way suppliers are selected.

Second, Gilley et al. (2004b) included firm maturity (firm age) as an antecedent of outsourcing, because

less mature firms simply lack the resources to internalize all functional activities.

Third, Van den Berghe and Carchon (2002) suggest that family-owners in Belgium tend to monitor their

companies very closely, and like to personally monitor the firm’s management, which might explain the

low outsourcing intensity. Similarly, Jayaraman et al. (2000) argue that family-owners tend to hold

substantial influence over the behaviour and performance of smaller firms.

Fourth, Bennett and Robson (1999) found that firm size is an important factor influencing the extent to

which SMEs use external service providers. Size of the firm was measured through total assets. Sales, as

found in the financial statement data of the Belfirst Database, could not be used, since small firms do not

disclose their turnover in Belgium, leading to considerable missing data. The number of employees is not

a good proxy when studying outsourcing, since the number of employees is directly dependent upon the

outcome of the outsourcing decision (Leiblein and Miller, 2003).

Fifth, Park and Krishnan (2001) found that industry has a powerful influence on a small firm’s selection of

suppliers. Brouthers and Brouthers (2003) found different drivers for manufacturing and service

companies for entry mode choices. However, there is no reason to expect that service and manufacturing

companies differ, in terms of outsourcing of the accounting function. Industry was measured using the

NACE-code, provided in the Belfirst Database. We used the first digit to distinguish between

manufacturing (code 0 to 4) and service companies (code 5 to 7).

16
Finally, we controlled for the existence of a separate CFO function in the SME. An analysis of our

database revealed that the CEO and CFO functions sometimes are performed by one person, whereas

other SMEs have separated these functions. When the CEO also performs the CFO function, it can be

argued that he or she will seek more assistance from an external accountant.

Common Methods Variance Bias

According to Hair et al. (1998), common methods variance bias can emerge when dependent and

independent variables all come from a single respondent. In order to avoid this bias, two countermeasures

were taken. First, the dependent variable (outsourcing intensity) is an objective measure rather than a

perception. Second, some of the control variables (total assets, industry and the existence of a separate

CFO function) were obtained from secondary sources. Furthermore, Harman’s single-factor test, as

suggested by Podsakoff and Organ (1986), reveals six factors when we load all variables. The most

influential factor explains only 17 per cent of the variance. We can conclude that common methods

variance is not a significant problem in our data set.

Results

Table III and Table IV contain descriptive statistics and correlations. With respect to the independent

variables, descriptive statistics indicate that substantial variability exists. An examination of the

correlation matrix reveals no substantial indication of collinearity. Furthermore, all tolerance values are

higher than 0.74, which is well above the common cut-off threshold. All variance inflation factor values

are lower than 1.36, and are below the threshold (Hair et al., 1998). Hence, multi-collinearity is not a

significant problem in our data.

[Insert Table III]

[Insert Table IV]

17
The first regression model in Table V has an F-value of 6.013 (p < .001) and indicates that the eight

control variables explain 24,4% of the variance in outsourcing intensity. When the seven explanatory

variables are entered into the regression model, the new model has an F-value of 5.916 (p < .001) and

explains 37,3% of the variance in outsourcing intensity. Based upon the results of the second regression

model, (see Table V), we can formulate conclusions for the following supported hypotheses.

H1: The higher the asset specificity of accounting tasks, the less intensely they are outsourced.

As predicted, asset specificity was significantly and negatively associated with outsourcing intensity. This

support for H1 is consistent with the core proposition of transaction cost theory, asserting that, with high

asset specificity, SMEs would rather internalize than outsource accounting activities (Williamson, 1985;

Eisenhardt, 1989).

H2: The higher the environmental uncertainty on accounting tasks, the less intensely they are outsourced.

Environmental uncertainty was marginally significant, but positively associated with outsourcing

intensity. This is contradictory to what we expected and to the basic transaction cost reasoning behind this

variable (Klein et al., 1990; Williamson, 1991; Hennart, 1994).

H4: The higher the frequency of accounting activities, the less intensely they are outsourced.

Frequency significantly explains the outsourcing intensity of accounting activities in the expected

direction. The data confirmed that, probably thanks to economies of scale, SMEs with fewer recurrent

accounting tasks are more likely to outsource (Williamson, 1985; Murray, 2001).

H7: The higher the deficit of a firm’s own resources and competencies related to accounting, the more

intensely the accounting activities will be outsourced.

Resource deficit significantly explains the outsourcing intensity of accounting activities among this

sample of SMEs. Consistent with results from Grant (1996) and Dibbern and Heinzl (2001), the regression

18
coefficient tells us that the higher the resource deficit related to accounting activities, the more it is

attractive for SMEs to use an external accountant.

From the list of control variables, we can conclude that the field of education of the SME-executive has a

significant impact on the outsourcing intensity of accounting. Executives lacking an economics-oriented

education are more attracted to outsourcing for accounting services. Moreover, the existence of a separate

CFO function significantly influences the outsourcing decision. SMEs do more outsourcing of accounting

tasks when they do not have a separate CFO function.

[Insert Table V] [ii]

Discussion, Limitations and Recommendation

Conclusions

The purpose of this study was to identify the determinants behind the outsourcing of accounting services

among small and medium-sized firms. We started using the extended TCE model (Gilley et al., 2004b;

Brouthers & Brouthers, 2004), and included resource deficit, as suggested by resource-based theory

(Barney, et al., 2001). Personal characteristics of the SME executive were added as control variables

(Hambrick and Mason, 1984).

First, resource deficit had the highest explanatory power, explaining 20 percent of the variance in

outsourcing intensity. As hypothesized, we idenified a positive relationship between resource deficit and

outsourcing intensity. Small firms principally outsource because they lack adequate resources within their

own firm to satisfy all their functional needs. This is consistent with results from a study by Beaumont and

Sohal (2004), who found “access to skills they don’t have” to be the major reason that small

manufacturing firms outsource for business processes.

19
Second, we found that frequency had a significant impact on outsourcing intensity. Consistent with the

TCE model, we found that, when accounting tasks have a low frequency, they will be more intensely

outsourced.

Third, asset specificity also was a significant determinant in the decision to outsource. As hypothesized,

accounting activities seem to contain many idiosyncratic assets in SMEs, such as specialist skills and

company-specific software, which are costly to transfer.

Four, we found a positive sign for environmental uncertainty, indicating that SMEs with highly variable

and less predictable accounting tasks (e.g. because of seasonal trends or mergers and acquisitions) more

intensively outsource their accounting tasks. This direction is contrary to what should be expected based

upon TCE (Williamson, 1991; Hennaert, 1994). Perhaps this can be linked to the reasoning behind risk

aversion, as proposed by Lever (1997) and Gilley et al. (2004b): Uncertainty with respect to the future

workload for the internal accountant makes outsourcing attractive, because it allows firms to shift much of

the risk associated with declining demand (e.g. head-count reductions) to the service provider.

Fluctuations in workload may make render internal accountants inadequate in times of high demand, and

relatively idle in times of low demand. Outsourcing, then, is a tactic to divide the risks between the firm

and the external accountant. Following the rationale of Gilley et al. (2004b), outsourcing offers the

advantage of improved flexibility, so that the SME is protected against a turbulent and unstable workload.

By contracting with an external accountant who can specialize, because of superior talent and resources,

the SME can avoid the idle capacity or capacity shortage of internal accountants. However, including the

risk aversion of the SME executive did not yield any significant result, so that our explanation for

environmental uncertainty warrants further investigation.

Furthermore, we did not identify support for behavioural uncertainty as a driver for outsourcing. This may

be due to the specific context of the study. Respondents of the pre-test cited that legal offices (e.g. VAT,

taxation, government institute responsible for collecting financial statements) would alert management if

the accountant made a mistake. Furthermore, many software tools are available nowadays to check the

20
accuracy of data. Also, in an audit context, Widener and Selto (1999) could not identify support for this

driver.

Trust of the SME executive in the external accountant was not found to be a significant driver for

outsourcing intensity. Trust was significantly negatively-correlated with behavioral uncertainty, which

makes sense, because both variables include a performance evaluation of the external accountant.

Apparently, subjective factors are not the main drivers in the decision to outsource accounting tasks.

In addition, the control variables in the model suggest that the characteristics of the CEO and

organizational factors do matter in outsourcing decisions, as suggested by Gilley et al. (2004b). (1) Firms

in which the CEO has received an economically- oriented education tend to be significantly less involved

in outsourcing. Perhaps these CEOs do not feel any need to outsource, because they possess the relevant

skills and knowledge to supervise the accounting tasks within the company. (2) Firms that have a separate

CFO function are more likely to keep accounting in-house. Such firms probably have developed more

expertise in accounting tasks than firms in which the CEO also is the CFO, since the separate CFO has

enough time on his hands to specialize in the matter.

Limitations

This study has several limitations. First, despite considerable effort to maximize response rate, the sample

size is rather limited. Hence, we do not know if the investigated companies included in the study are

representative of the target population. Second, because we examined only Belgian SMEs, our findings

may not be generalizable to firms from other countries. Third, because of our small sample size, we only

could contrast manufacturing with service companies. A larger sample would allow for detailed cross-

sector comparisons. Fourth, firm maturity was not significant, but we had a limited number of young

companies in our sample. Including a broader range of company ages might unveil a significant

relationship between firm maturity and outsourcing. More research is needed here.

21
Future Research

Future research efforts may focus on some remaining issues. First, the constructs we used were adapted

to fit the accounting context of the study. In particular, for frequency, we added a volume element in

our operationalization. Preliminary interviews revealed that periodicity (the number of recurrent tasks

during a year) and the length of the task (volume of invoices) both are important elements of frequency in

accounting. Traditionally, Williamson (1979) makes a distinction between one-time, occasional

services and recurrent services. We suggest that future research includes both of these interpretations of

frequency, in order to develop a better understanding of the frequency construct in an accounting context.

However, one also could question whether this distinction between periodicity and volume only applies to

the accounting context.

Second, future research should focus more closely on environmental uncertainty. We have no satisfactory

explanation for the positive association with outsourcing intensity, as risk aversion of the SME executive

is not significant. We remain unsure as to whether the variable of risk aversion was captured adequately or

whether there is an alternative explanation for dividing the risks with the external accountant when there is

an unstable workload. Alternatively, environmental uncertainty may not be an issue in accounting,

contrary to what TCT would predict.

Third, although trust is not a significant determinant in our study, we feel it is important to examine the

concept more closely. Considering the confidentiality of accounting data, SMEs must be certain that the

provider is trustworthy and adequately capable, before they outsource. Therefore, more work needs to be

done on the level of satisfaction of entrepreneurs. It seems logical that SMEs that are content with their

relationship with an external accountant will exercise a greater intensity of outsourcing. Additionally, one

should make a distinction between different types of trust. Although we focussed on interpersonal trust,

one also might examine inter-organizational trust.

Fourth, viewing our analysis from an international perspective, we found that outsourcing is much

more common than generally acknowledged. Kakabadse and Kakabadse (2002) found, in their

22
Cranfield study, that 13 percent of European and American companies are outsourcing

accounting/financial services. We found that SMEs are outsourcing an average of 34 percent of their

workload related to accounting, which is quite high. Is this typical for small and medium-sized

firms?

Finally, outsourcing commonly is considered to be dichotomous. However, our results indicate that there

are multiple forms of outsourcing (ranging from 1 percent to 100 percent outsourcing). In the accounting

context, a combination of internalizing and outsourcing is the most frequently chosen option. The external

accountant frequently reviews what has been prepared by the internal accountant. We, therefore, support

the call of Gilley and Rasheed (2000) to do more research on outsourcing intensity as a

dependent variable, because it captures both the number of outsourced tasks (breadth) and the

degree of outsourcing for each task (depth). This also may explain why international comparisons,

such as the study by Kakabadse and Kakabadse (2002), find much lower degrees of outsourcing, because

such studies may limit outsourcing to the situation wherein all tasks are 100 percent outsourced.

23
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 Figure 1: The annual accounting process

Entry of invoices and Interim Period-end Financial

financial transactions Reporting Accounting Statements

VAT Corporate tax

Compliance Compliance

30
 Table I: Reliability Measures and Factor Loadings for Variables with Multiple Items

Measures and items Alpha Alpha Factor Source

Loading
Outsourcing Intensity (ranging from 0% to 100%) 0.87
1. Entering up purchase invoices, sales invoices and financial X Adapted from
transactions Gilley and
2. Preparation of interim profit and loss account X Rasheed
3. Period end accounting X (2000)
4. Preparation of financial statements X
5. Belgian VAT compliance X
6. Belgian corporate income tax compliance X
Asset Specificity (1 totally disagree 5 totally agree) 0.56 0.63
1. To acquire the routine accounting tasks the accountant needs to X 1, 2, 5:
acquire company-specific information Adapted from
2. To perform the non-routine accounting tasks the accountant X Poppo and
needs to acquire company-specific information Zenger (1998)
5. It would be costly in terms of time and resources to switch to X X 0.789
an external accountant at the end of the financial year. 3, 4: Adapted
Or in case the company uses an external accountant (for some from Erramilli
tasks): It would be costly in terms of time and resources to switch and Rao
to another external accountant at the end of the financial year. (1993)
3. The accounting software is custom-tailored to our company X X 0.749
4. The way we perform the accounting tasks is unique to our X X 0.746
company
Environmental Uncertainty (1 totally disagree; 5 totally agree) 0.67 0.82 Adapted from
1. During the previous year, there was a lot of variation in the X X 0.905 John and
workload related to routine accounting tasks Weitz (1988)
2. During the previous year, there was a lot of variation in the X X 0.861
workload related to non-routine accounting tasks (e.g. period end-
accounting).
3. During the previous year, there were relevant changes in the X
business organization of the company (e.g. acquisitions, changes
in corporate structure).
Behavioral Uncertainty (1 totally disagree; 5 totally agree) 0.91 Adapted from
Is it possible to determine whether the accountant has correctly Poppo and
(accurately) performed the following activities?* Zenger (1998)
1. Entering up purchase invoices, sales invoices and financial X 0.843
transactions
2. Preparation of interim reports (e.g. interim profit and loss X 0.838
account)
3. Period end accounting (depreciations, stock changes, loans, X 0.875
accruals and deferred income, …)
4. Preparation of financial statements (balance sheet, profit and X 0.792
loss account)
5. Belgian VAT compliance X 0.848
6. Belgian corporate income tax compliance X 0.776
Frequency: periodicity 0.63
1. Entry of purchase invoices, sales invoices and financial 0.545 New measure
transactions (1 daily 6 annually)*
2. Preparation of interim profit and loss account (1 daily; 6 0.626
annually)*
3. Period end accounting (1 daily; 6 annually)* 0.802
4. Preparation of financial statements (1 daily; 6 annually)* .699
5. Total amount of invoices (sales and purchases) that the .447
accountant has processed during the previous year?

31
 Based on
Trust (1 totally disagree; 5 totally agree)
0.89 Zaheer et al.
1. The CEO has confidence that the external accountant will treat X 0.799 (1998), but
us fairly, this means to correctly charge for the performed duties. largely
2. The CEO has confidence that the external accountant will X 0.928 adapted to
inform us correctly. accounting
3. The CEO has confidence that the external accountant will X 0.890
accurately perform the duties.
4. The relationship between the CEO and the external accountant X 0.811
is based on trust.
Risk Aversion (1 totally disagree; 5 totally agree) 0.85 Adapted from
1. The CEO is willing to engage in risky business projects* X 0.825 Miller and
2. The CEO is considering less obvious and more risky X 0.890 Friesen (1982)
alternatives for the firm*
Resource Deficit (1 totally disagree; 5 totally agree) 0.86 Adapted from
1. The competences of the external accountant related to financial X 0.892 Dibbern and
accounting are higher than the current internal competencies. Heinzl (2001)
2. The competencies of the external accountant related to X 0.825
financial accounting are higher than the future internal
competencies.
* reverse coded

32
 Table II: Calculation of Outsourcing Intensity

Answers from Company XYZ

Workload performed by Workload performed
external accountant by internal accountant
Entry of invoices and financial transactions 0% 100%
Preparation of interim profit and loss account 0% 100%
Period end accounting 50% 50%
Preparation of financial statements 100% 0%
Belgian VAT compliance 0% 100%
Belgian corporate tax compliance 60% 40%
Calculation of outsourcing intensity for Company XYZ
Outsourcing Breadth: 3/6 = 50%
Outsourcing Depth: (50% + 100% + 60%)/3 = 70%
Outsourcing Intensity= Breadth x Depth: 50% x 70% = 35%

33
 Table III: Descriptives

N Min. Max. Mean S.D.

Outsourcing intensity 126 0.00 100.00 34.19 28.92

Asset specificity 126 1.00 5.00 3.07 0.82

Environmental uncertainty 126 1.00 5.00 2.41 0.78

Behavioural uncertainty 126 1.00 4.00 2.05 0.60

Frequency 126 1.00 4.00 2.23 0.62

Resource deficit 126 1.00 5.00 3.78 0.97

Trust 126 2.50 5.00 4.18 0.57

Risk aversion 126 1.00 5.00 2.91 0.86

Age of SME-executive 126 27.00 67.00 48.24 8.64

Firm size (total assets in 1,000 Euro) 126 400 578,910 11,884 53,913

34
 Table IV: Correlation matrix

University_d

Economic_d

Age_comp

Frequency
Service_d
Outintens

Family_d
Age_ceo

Env_unc

Beh_unc
As_spec

Risk_av

Res_def
CFO_d

Trust
Size
Outintens 1 -.039 -.344** -.249** .285** -.006 .032 -.121 -.410** -.167 -.029 .040 -.392** .163 .082 .453**
Age_ceo -.039 1 -.017 -.141 -.012 .010 .101 .039 .004 .021 -.044 .022 -.034 .083 .227* .020
University_d -.344** -.017 1 .153 -.213* .085 -.051 .175* .260** .052 .134 -.176* .355** .072 -.087 -.232**
Economic_d -.249** -.141 .153 1 .004 .114 .128 -.078 .225* -.027 .022 -.118 .097 .099 -.081 -101
Family_d .285** -.012 -.213* .004 1 -.070 .150 -.217* -.094 .131 -.078 .097 -.305** .223* .093 .227*
Service_d -.006 .010 .085 .114 -.070 1 .001 -.100 -.128 -.098 -.112 -.176* .168 -.106 .086 .003
Age_comp .032 .101 -.051 .128 .150 .001 1 .051 .078 .109 .267** .117 -.110 .060 .213* -.047
Size -.121 .039 .175* -.078 -.217* -.100 .051 1 .118 .012 .085 .010 .214* -.091 .081 .041
CFO_d -.410** .004 .260** .225* -.094 -.128 .078 .118 1 .125 .228* -.030 .205* -.113 -.130 -.262**
As_spec -.167 .021 .052 -.027 .131 -.098 .109 .012 .125 1 .165 -.013 .022 .077 .033 -.079
Env_unc -.029 -.044 .134 .022 -.078 -.112 .267** .085 .228* .165 1 .105 .007 -.124 .035 -.152
Beh_unc .040 .022 -.176* -.118 .097 -.176* .117 .010 -.030 -.013 .105 1 -.192* -.211* .071 -.075
Frequency -.392** -.034 .355** .097 -.305** .168 -.110 .214* .205* .022 .007 -.192* 1 .022 -.071 -.209*
Trust .163 .083 .072 .099 .223* -.106 .060 -.091 -.113 .077 -.124 -.211* .022 1 .004 .246**
Risk_av .082 .227* -.087 -.081 .093 .086 .213* .081 -.130 .033 .035 .071 -.071 .004 1 .109
Res_def .453** .020 -.232** -.101 .227* .003 -.047 .041 .-262** -.079 -.152 -.075 -.209* .246** .109 1

* : significant at p < .05 ** : significant at p < .01

35
 Table V: Multiple regression analysis

Model 1: Model 2:
Control Variables Control and
explanatory variables
Coeff. T-value Coeff. T-value
Constant 2.306** .927
Age of current CEO -.067 -.840 -.076 -1.021
University degree of CEO -.191 -2.277** -.126 -1.544
Economic orientation of education CEO -.169 -2.034** -.180 -2.327**
Family firm .205 2.484** .121 1.487
Service firm .004 .048 .048 .618
Age of the firm .045 .552 .028 .348
Size of the firm -.020 -.244 -.022 -.277
Existence of separate CFO function -.301 -3.578*** -.203 -2.492**
Asset specificity -.159 -2.136**
Environmental uncertainty .130 1.657*
Behavioural uncertainty -.026 -.339
Frequency .-.201 -2.423**
Trust of CEO in accountant .111 1.363
Risk aversion of CEO -.013 -.175
Resource deficit .265 3.269***

R² .293 .449
Adjusted R² .244 .373
F-value 6.013*** 5.916***

* : significant at p = .10 ** : significant at p < .05 *** : significant at p < .01

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 Endnotes

[i] Sampling method is not significant when included in model 1 (t = -.096; p = .924) and the
significance of all other variables (control), as reported in Table V, does not change. Sampling method
also is not significant when included in model 2 (t = -.079; p = .937) and the significance of all other
variables (control and explanatory), as reported in Table V, does not change.

[ii] When leaving out those SMEs that perform all accounting activities internally (n=21), the second
regression model exhibits similar explanatory power (adjusted R²= .350), but a lower F-value (F =
4.701). Furthermore, hypothesis 2 (environmental uncertainty) is not supported anymore (p = .33) and
frequency (hypothesis 4) only is marginally significant (p = .10).

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