Second-versus Third-party Audit Quality: Evidence from Global Supply Chain Monitoring †

Abstract

Capitalizing on the superior credibility and flexibility and potential lower cost of external assessments, many global buyers are relying less on their own employee ("second-party") auditors and more on thirdparty auditors to monitor and prevent environmental and social misconduct in supply chains. Despite ingrained assumptions that third-party auditors' greater independence reduces bias and improves audit quality, there are concerns that this trend risks eroding audit quality. Drawing on agency theory for a more nuanced understanding of auditor incentives and on data from a global fashion brand, we find third-party auditors indeed less effective, especially as a given factory's region exhibits more reported corruption or less potential oversight by second-party auditors. Global buyers can bolster third-party-audit quality by increasing the presence of second-party auditors in a given region, emphasizing such deployment in more corrupt regions, and rotating amongst third-party audit firms. Our findings can inform better-designed monitoring not only of suppliers, but also of other business partners that create risks for brands, such as franchisees, distributors, vendors, and purchasing agents.

Keywords: supply chain management, auditing, working conditions, sustainability, empirical operations management