By Christoph M. Schiller, Arizona State University, W.P. Carey School of Business
Over the last few decades, supply chains have become increasingly globalised and highly integrated. Many firms have built tightly integrated production networks with their upstream suppliers in countries around the world, potentially exposing themselves to adverse reputational shocks and legal risks, such as human rights violations or toxic emissions scandals, at their supplier firms. Consequently, in a 2016 survey, 41% of CEOs indicated that “preventing disruptions of the supply chain” was a key motivation for investing in corporate social responsibility (CSR).
Despite this rapidly growing attention by executives and supply chain practitioners, academic research has been largely silent on the role of global supply chain networks for CSR. In my research, I fill this gap by studying if and how foreign corporate customers and environmental and social (E&S) regulations in their home countries drive suppliers’ CSR performance and documenting what the resulting outcomes are.
Prior academic research has argued that imposing stronger E&S requirements on firms can increase production costs, which might lead to higher input prices for upstream customers. Further, researchers have documented that firms may shift dirty economic activities to countries with weaker regulatory standards when facing stricter emissions requirements (known as the pollution haven hypothesis). Following this rationale, we would not expect customer firms to impact their suppliers’ CSR performance positively. On the other hand, firms that depend on highly integrated supply chains are exposed to disruptions at their upstream suppliers, for example due to emissions scandals or labour law violations, and hence have a strong incentive to mitigate such reputational, legal and operational risks in their supply chains.
Examining supplier-customer relationships
To examine this tension, I study if suppliers’ CSR scores increase significantly following the adoption of additional CSR policies at their customer firms, using a comprehensive sample of 70,000 supplier-customer relationships across 52 countries from 2004 to 2016. I find that CSR policy adoption at the customer firms – such as initiatives to reduce environmental emissions and toxic waste or health and safety monitoring – has a positive effect on upstream supplier CSR performance, as measured by Thomson Reuters CSR scores. Consistent with the idea that customers directly influence their suppliers, this effect is particularly strong when customers have high bargaining power with their suppliers, and when they are located in countries with high E&S regulations and standards.
A key concern with this analysis is the possibility that other factors might be driving suppliers’ CSR scores and customers’ CSR policies. For example, institutional investors such as pension funds or activist hedge funds might be simultaneously lobbying these firms to clean up their business practices.
To address this, my main tests focus on pairs of suppliers and customers located in different countries and study how the supplier’s CSR performance changes following the introduction of new E&S regulations in the customer’s country. For this purpose, I review and compile national regulation changes related to CSR reporting and E&S standards in over 30 countries from Carrots & Sticks, a database and accompanying series of reports. The supplier firms in this setting are affected by E&S-related regulation changes only through their relationships with foreign customers. I use other supplier firms in the same country without foreign customers in the country with the regulatory change as a control group. Since national regulations in a foreign country are unlikely to be influenced by suppliers or institutional investors, this approach helps to rule out alternative explanations and reverse causality.
I find that suppliers’ E&S scores increase by 3% to 4% more than those of suppliers in the control group, following the introduction of new E&S regulations affecting their foreign customers.
An important question is if this propagation of CSR policies from customers to suppliers has real environmental and social consequences, or if increased supplier CSR scores are primarily the result of corporate greenwashing. Using data from the US Environmental Protection Agency’s Toxic Release Inventory program, which requires firms to report detailed emissions records across hundreds of toxic chemicals, I show that US suppliers significantly reduce their toxic emissions when foreign customers – especially those in countries with high E&S standards and those with high bargaining power – are subject to new E&S reporting requirements. Firms particularly reduce emissions with a high risk for human health, such as cancer-causing chemicals. I also find that customer CSR adoption reduces the likelihood of E&S-related penalties and lawsuits at their suppliers. These findings indicate that CSR propagation along the supply chain has real social and economic consequences.
Finally, I examine how CSR propagation affects the financial performance of suppliers. The question of whether CSR activities are costly for shareholders or if, alternatively, firms can do well by doing good has been intensely debated. It is especially challenging since CSR activities are often closely related to other firm characteristics, such as access to capital, making it difficult to distinguish cause and effect.
I use the introduction of E&S regulations in the countries of customer firms to study the effect on the financial performance of US-based suppliers. Contrary to the idea that downstream suppliers bear the financial cost of their customers’ CSR demands, I find that suppliers’ operating performance and stock market valuations, measured by return on assets and Tobin’s Q respectively, improves following the introduction of foreign E&S regulations and customer CSR policies, compared to the control group. This might be due to the suppliers’ ability to attract new foreign customers after improving their CSR scores.
These findings indicate that supply chain relationships are an important driver for corporate CSR adoption and performance, as customers influence their suppliers’ CSR policies to reduce supply-chain-related risks
This has significant implications for corporate managers and investors. For example, activist investors who want to engage firms on CSR activities should pay close attention to existing supply chain networks to maximise the effect of their engagements. Further, suppliers’ financial performance suggests that there are economic benefits to being perceived as good by important external stakeholders in addition to private consumers and employees. Third, global supply chains can act as a channel to transmit regulatory requirements and institutional standards across borders. This is especially relevant to policy makers and regulators as it challenges the pollution haven hypothesis. In contrast, the results support the idea that E&S regulations have a positive effect on upstream suppliers, especially when the discrepancy between the downstream and upstream country is large.
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 For example, in 2011 over a hundred workers were poisoned by chemicals used in the production of iPhone screens at a Chinese electronics manufacturer. In response, Apple tripled its CSR staff, intervened directly in the supplier’s production process, and started monitoring supplier facilities. See http://www.scmworld.com/wp-content/uploads/2017/07/Future_of_Supply_Chain_2016_.pdf for more detail.
 The database is published by KPMG, the Global Reporting Initiative, the United Nations Environment Programme and the University of Stellenbosch Business School. It contains mandatory and voluntary instruments that either require or encourage organisations to report sustainability-related information – for example, France passing the Grenelle Act II, which requires publicly listed firms to report on over 40 E&S indicators and third-party verification, in 2012.
 Given that EPA data is only available for US firms, these tests focus on US suppliers and their foreign customers.