Managing Supplier Social & Environmental Impacts with Voluntary vs. Mandatory Disclosure to Investors

Abstract

A buying firm might in future incur costs associated with a supplier’s CO2 emissions, safety violations or other social or environmental impacts. Learning about a supplier’s impacts requires costly effort, but is necessary (and sometimes sufficient) to reduce those impacts. The capital market valuation of a buying firm reflects investors’ estimate of future costs associated with a supplier’s impacts, as well as any costs that the buying firm incurs in order to learn about and reduce a supplier’s impacts. This paper analyzes a game theoretic model in which a manager- with the objective of maximizing the capital market valuation of the buying firm- decides whether or not to learn about a supplier’s impacts, how much cost to incur to reduce the supplier’s impacts, and whether or not to disclose the supplier’s impacts to investors; the investors have rational expectations (e.g., that a manager might withhold bad news about the supplier’s impacts) and value the buying firm accordingly. The paper considers a mandate to disclose information learned about a supplier’s impacts. The paper shows that the disclosure mandate deters learning and thus, under plausible conditions, results in higher expected impacts. The disclosure mandate can result in lower expected impacts only if buying firms face moderately high future costs associated with suppliers’ impacts. In contrast, a disclosure mandate always increases a buying firm’s expected discounted profit and capital market valuation. A disclosure mandate can induce cooperation among buying firms with a shared supplier, yet result in higher expected impacts by the supplier. When a buying firm has alternative suppliers, the disclosure mandate favors commitment to a supplier to facilitate learning about that supplier’s impacts (instead of searching for a lower-impact supplier).