The Impact of Socially Responsible Customers of Corporations

Corporations worldwide are increasingly integrating corporate social responsibility (CSR) into their operations and emphasizing ethical, safe, and sustainable business practices. Also, anecdotal evidence suggests that many of these corporations are concerned about not only their own CSR standards but also those of their suppliers. Some scholars argue that the increasing popularity of CSR comes in part, in response to the repeated failures of laws and regulations protecting stakeholders, prompting stakeholders to protect their own interests by pushing companies to engage in CSR. However, it is not clear whether corporate customers, among the most important stakeholders, are pushing suppliers to engage in socially responsible business practices or merely giving CSR lip service.

In a new study, we explore whether and how corporate customers influence CSR practices in global supply chains. We also examine the economic implications of collaborative CSR efforts between customers and suppliers that are prompted by customers.

We exploit several unique international databases to test whether socially responsible corporate customers can infuse similar socially conscious business behavior in suppliers. The two primary  databases are: (1) a newly available FactSet Revere database that provides information on firm-level networks of customers and suppliers around the world, and (2) Thomson Reuter’s ASSET4 Environmental (E), Social (S), and Corporate Governance (G) database (ASSET4), which contains ASSET4 ratings (i.e., a composite firm-level CSR rating) as well as more than 750 constituent ESG ratings of global publicly listed firms. After merging these two databases, our sample consists of 34,117 unique corporate customer-supplier pairs from 50 countries for the period from 2003 to 2015. Using this sample, we find evidence of a significant unilateral effect of customers’ socially responsible behavior on their suppliers, suggesting that corporate customers make real efforts to ensure suppliers engage in similar CSR standards. Suppliers, however, do not  influence customers’ CSR activities. In terms of magnitude, a one standard-deviation-change in the customer CSR rating will generate about an 8 percent aggregate increase in future CSR performance of suppliers through the customer’s direct network. In addition, we find that locations of customers and suppliers affect the degree of CSR in supply chains. Customers play a crucial role in improving CSR standards at their suppliers when their countries have similar standards of CSR.

To test causation, we first apply a regression discontinuity design (RDD) that relies on exogenous variation generated by voting outcomes of customers’ shareholder-sponsored CSR proposals that pass or fail by a small margin of votes (around the actual majority hurdle) during shareholder meetings. The passage of these proposals is similar to a random assignment of CSR to firms and hence should not directly influence the supplier’s future CSR performance and thus can be used to estimate the causal effect of a customer’s CSR commitment on its supplier’s CSR practices. Our results suggest that the passage of a customer’s CSR proposal by a narrow margin is followed by the adoption of similar CSR practices by its supplier. The latter’s CSR score in the following year is significantly higher than for suppliers where CSR proposals fail to pass by a small margin.

In another test, we use unexpected product safety scandals that created global shocks to consumers and the general public and find stronger customer influence on supplier CSR following these shocks. Since our analysis looks at the same customer-supplier pair before and after the shocks, the positive CSR effect should be attributed to the customer’s immediate push for suppliers to improve their socially responsible behavior. An additional test also suggests that such scandals result in an increase in the supplier’s reputation risk index and ultimately that of  the customer’s as well.

We identify two mechanisms through which customers drive CSR in suppliers. The first is a positive assortative matching of CSR attributes. Customers tend to establish relationships with suppliers that are likely to exhibit socially and environmentally responsible behavior. On the other hand, customers may terminate these relationships if suppliers are unable to meet the customers’ CSR demands. If the assortative matching is the mechanism, a severance of the economic link does not imply a weakened CSR spillover effect, unless such terminations are exogenous. We test this mechanism on a sample of newly linked and delinked customer-supplier relationships. Additionally, we construct a sample of target customer and supplier firms that are acquired by corporations with no prior economic link with either the target customer or the target supplier. We consider such target firms a source of exogenous variation of the CSR effect. When a supplier or a customer is targeted and successfully acquired by another firm that is not part of the supply chain, we expect the stakeholder effect of CSR to become weaker. The results are in line with our expectations.

The second mechanism is the bargaining power of customers and suppliers. We argue that the bargaining power of a customer depends on its reliance on the relationship-specific investment (RSI) made by its supplier and the competition intensity of an industry. When the customer depends heavily on its supplier’s RSI, it has less power to impose greater, typically costly, CSR commitment on the supplier. Prior literature suggests that customers from research-intensive industries tend to require their suppliers to make investments consistent with their own. We employ a supplier’s level of R&D and number of patents registered as measures of RSI. Similarly, we expect a customer to be powerful when its industry is more concentrated, or when its supplier’s industry is highly competitive. The results suggest that customers are less inclined to affect their supplier’s CSR performance when the supplier is highly innovative, or when the supplier’s Herfindahl-Hirschman index (HHI, a measure of industry competitiveness) is low, or when the customer’s HHI is high.

The extent to which a customer can push a supplier for more environmental and social responsibilities may depend on network connectedness. One strand of literature suggests that common ownership produces positive externalities as shareholders aim to maximize the value of all firms in their portfolio  rather than just individual ones. Another strand finds that boards with interlocking directors often behave similarly. We therefore expect that common investor and board networks in a customer-supplier pair facilitate CSR propagation. In other words, when an investor of a customer firm  also holds a stake in a supplier firm, or a director from the customer’s board also serves on the supplier’s board, the customer wields significant influence. Our overall evidence is consistent with this prediction.

Finally, we evaluate the economic impact of collaborative CSR efforts of customers and suppliers through their alignment of CSR standards. Previous studies show value enhancements in corporations that implement CSR. However, doing so can be costly. Our analysis, however, suggests that more collaboration helps improve efficiency and firm value for both the customer and supplier but enhances only the customer’s future sales.

Overall, our study suggests that increasing one firm’s CSR can have a ripple effect across global supply chains. However, our finding of the one-way CSR effect from customers to suppliers, which occurs only in some countries, suggests that such effect is are bounded by a firm’s position in the global network and its socio-cultural and institutional environment. This potentially indicates that CSR policies cannot be universally applied.

Our findings also shed light on some fundamental issues in industrial organization and strategic management, such as why some firms push others to adopt certain practices. It may simply make economic sense, because, as corporate customers, they can benefit from increased sales throughout the supply chain. It is therefore unsurprising that these companies are also more responsive to product safety scandals, as these events are closely related to consumer perception and future purchases of their products.

This post comes to us from Rui Dai at Wharton Research Data Services, Professor Hao Liang at Singapore Management University’s Lee Kong Chian School of Business, and Professor Lilian Ng at York University’s Schulich School of Business. It is based on their recent paper, “Socially Responsible Corporate Customers,” available here.