Responsible Sourcing under Supplier-Auditor Collusion
46 Pages Posted: 21 Jul 2016 Last revised: 14 Oct 2019
Date Written: June 17, 2019
Problem Definition: While enjoying low costs in sourcing from emerging economies, global brands also face serious brand and reputation risks from their suppliers' noncompliance with environmental and labor standards. Such supplier problem can be viewed as a process quality problem concerning how products are sourced and produced. Academic/Practical Relevance: Addressing this problem is a key component of many global companies' responsible sourcing programs. A common approach is to use audit as an auxiliary supplier screening mechanism. However, in regions with lax law enforcement, an unethical, noncomplying supplier may attempt to bribe an unethical auditor to pass the audit. Such supplier-auditor collusion compromises the integrity of the audit and weakens its effectiveness. Methodology: In this paper, we develop a game-theoretical model to study the effect of supplier-auditor collusion on the buyer's auditing and contracting strategy in responsible sourcing, as well as various driving factors that help reduce collusion. Results: We show that the buyer's equilibrium contracting strategy is a shutout contract that takes three different forms, depending on the collusion risk level. We also define and analyze the screening errors and social efficiency loss caused by supplier-auditor collusion. By comparing the cost versus collusion elimination tradeoff between third-party audit and in-house audit, we offer explanations for why many global brands fully rely on third-party audit and set higher process quality requirement for suppliers located in high risk countries. The robustness of our insights are verified by two model extensions: one involving additional supplier audit cost, and the other allowing for supplier process quality improvement before audit. Managerial Implications: These model insights provide useful theoretical support and baseline guidance for the current supplier audit practices in responsible sourcing. Our extended model analysis further demonstrates the importance for global brands to lobby local governments to increase collusion penalty and to promote the ethical level of the third-party auditors located in high risk countries.
Keywords: Responsible Sourcing, Supplier Audit, Supplier-Auditor Collusion, Information Asymmetry
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