Audit and Compliance in Supply Chains with Damage Cost Sharing under Supplier's Responsibility Standards
32 Pages Posted: 10 Oct 2022 Last revised: 29 Jun 2023
Date Written: October 6, 2022
Governmental regulations and industry standards are imposed to ensure responsible supply chain operations. Suppliers are primarily responsible to invest in following these standards, but if any violation occurs, the buyers are largely exposed to damage costs and loss of goodwill. This leads to incentive misalignment between buyers and suppliers. While audits are ``proactive safeguards” that a buyer can use to incentivize its supplier to comply with the standards, ``reactive safeguards” that hold a non-compliant supplier (partially) accountable for the damage occurred
may also be effective in curtailing supplier's noncompliance, especially when the supplier is a big, established entity.
Our work contributes to the literature on supply-chain responsiblity by analyzing the interplay between buyer audits and supplier compliance in the context of big-buyer-big-supplier supply chains (unlike in big-buyer-small-supplier ones) in which damages due to supplier's non-compliance are borne by both buyer and supplier, in the presence of pre-committed compliance standards.
We develop a multi-buyer-single-supplier game-theoretic model, where the supplier decides its compliance level to the industry standard, and each buyer determines its audit level. The supplier is liable to a fraction of the damage cost if it under-complies. We find that more stringent audits do not always result in more compliant supply chains. Under-compliance occurs if the standard is low and the buyers' audit costs are low.
Next, joint audits, where all buyers collectively audit the supplier and share the audit and risk-mitigation costs among themselves, can aggravate supplier’s under-compliance. However, shared audits, wherein each buyer independently audits the supplier but shares its audit information with all other buyers, can improve supplier’s compliance, especially when the compliance standard is low.
Finally, our results also show that
the supplier's profit is higher in joint audit than in independent audit, whereas the buyers' profits are highest under the audit scheme where their audit level is sufficiently high vis-\`a-vis the other schemes.
Keywords: supply chain risk, compliance standards, buyer audits, supplier compliance, socially responsible operations
Suggested Citation: Suggested Citation