What is most likely outcome for a company when it practices social responsibility to customers?

Today’s changing global businesses and corporate environments have brought about a new wave of corporate social responsibility (CSR) activities that go beyond the regulatory requirement of the country (Bénabou, Tirole, 2010, Kitzmueller, Shimshack, 2012). As corporations face increasing societal demands for more CSR activities,2 there appear growing corporate efforts to integrate social, environmental, and ethical concerns into their business operations. Anecdotal evidence, as well as the opening quote, has suggested that many corporate customers are concerned not only with their own CSR standards but also with those of their suppliers. Some scholars argue that the growing popularity of CSR activities around the world is, in part, in response to the repeated failures of laws and regulations protecting stakeholders, raising the need from stakeholders to protect their own interests through pushing the company to engage in CSR (Bénabou, Tirole, 2010, De Bettignies, Robinson, 2018). However, it is not apparent whether corporate customers, one of the most important stakeholders, are really taking actions to push suppliers to engage in socially responsible business practices, or whether their public mention of CSR commitment is simply a sideshow (see, e.g., Koehn, Ueng, 2010, Kitzmueller, Shimshack, 2012). Nevertheless, there is limited academic research on the role of corporate customers in influencing suppliers to conduct their business operations in a socially and environmentally responsible manner. Thus, the goal of our study is to explore whether and by which mechanisms corporate customers drive CSR practices in global supply chains around the world, and consequently, their economic implications for both customers and suppliers.

Increases in economic globalization, advancements in production and information technologies, and improvement in logistics have facilitated a dynamic growth in global supply chains. As corporations exploit these expanding opportunities, they face new challenges to properly enforce their own CSR policies across their global and complex supplier networks. Investing in CSR initiatives can be especially costly for corporations grappling with the difficulties posed by managing a global supply chain, but there are various arguments for why these firms would want their suppliers to implement such initiatives. For example, corporations may push suppliers to engage in CSR activities as a means of window dressing to appease various stakeholder groups and avoid negative publicity, may help recruit, motivate, and retain employees,3 may attract new customers and increase market share,4 may improve the firms’ image in the investment community and thereby their ability to access capital,5 among others. Also, research by practitioners has shown that environmental and social scandals associated with suppliers increase not only the suppliers’ own reputation risk index but also their customers’ and that such increases in reputation risks are accompanied by falling stock prices subsequent to the release of corporate scandals.6 Therefore, we hypothesize that customers are compelled to exert influence on suppliers for better CSR practices and that their actions have real economic consequences.

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 international 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) that 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 worldwide for the period from 2003 to 2015. Using this large international sample of corporate customer-supplier relationships, 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, exhibit no influence on customers’ CSR activities. In terms of economic significance, a one-standard-deviation change in the customer CSR rating will generate about an 8% aggregate increase in future CSR performance of suppliers through the customer’s direct network. These results are robust to the inclusion of a multitude of firm-level control variables, the log of a country’s gross domestic product per capita (ln(GDPC)), as well as different combinations of fixed effects. In addition, we find that locations of customers and suppliers matter for the working 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. Finally, our key finding is robust to using (i) differential CSR measures between customers and suppliers, (ii) alternative CSR databases (i.e., MSCI Intangible Value Assessment and Sustainalytics), (iii) social and environmental aspects of CSR, and (iv) falsification tests.

Our finding of strong correlations between customer CSR and subsequent improvement in supplier CSR might not reflect a causal relation since customers’ CSR practices might be correlated with their selective preference toward suppliers who are more likely to cooperate and commit to higher CSR standards. Thus, it is apparent that identifying the impact of customers on supplier CSR performance can be empirically challenging. One may tackle this identification issue by investigating the effect of an initial implementation of a country-level ESG regulation on CSR propagation along the supply chain. But such regulatory ESG mandates often have different implications from those arising from voluntary CSR engagements. As a consequence, any mandatory response taken by customers that in turn impacts suppliers may not necessarily suggest voluntary CSR actions made by customers beyond the regulation. To circumvent this identification problem, we examine the unilateral effect of customers on supplier CSR by using 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). The passage of these close-call proposals is similar to a random assignment of CSR to firms and hence should not influence the supplier’s future CSR performance. Conceptually, there should be no systematic differences between suppliers whose customers pass and those whose customers reject a CSR proposal by a small margin of the votes. Therefore, close-call CSR proposals provide a source of random variation of a corporate customer’s commitment to CSR that can be used to estimate the causal effect on its supplier’s CSR practices.7 Our results suggest that the passage of a customer’s close-call CSR proposal is followed by the adoption of similar CSR practices by its supplier. The latter’s CSR score in the following year is significantly higher (i.e., 24% of the standard deviation of CSR score) than the supplier’s in which the vote fails by a small margin.

In another identification strategy, we employ exogenous shocks related to unexpected product safety scandals that have created global shocks to consumerism and the general public,8 and find stronger customers’ influence on supplier CSR following these unexpected global shocks. Since our analysis looks at the same customer-supplier pair before and after the shocks associated with the scandals, the positive CSR effect should be attributed to the customer’s immediate push for suppliers to improve their socially responsible behavior in response to the scandal. In terms of economic significance, a one-standard-deviation increase in the customer’s product responsibility rating in the scandal year will generate a 9.0%–10.9% rise in the supplier’s mean product responsibility rating. An additional test also suggests that such scandals result in an increase in the supplier’s reputation risk index and ultimately lead to a rise in the customer’s reputation risk index as well. Combined, these results stemming from the two identification strategies allay potential endogeneity concerns on the impact of corporate customers on the CSR performance of suppliers.

Our evidence suggests that a key mechanism by which customers exert influence is through 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 (e.g., Banerjee et al., 2008). 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 (i.e., such firms are targeted not necessarily by their own choice) and successfully acquired by another firm which 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.

Another mechanism is through stakeholder bargaining power and/or through suppliers’ decision-making process. 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 be involved in specialized inputs that require their suppliers to make investments consistent with their own (e.g., Armour, Teece, 1980, Levy, 1985, Allen, Phillips, 2000, Dhaliwal, Shenoy, Williams, Chu, Tian, Wang, 2019). Following this strand of literature, we employ a supplier’s level of research and development (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 possibly depend on network connectedness. One strand of literature suggests that common ownership produces positive externalities as shareholders aim to maximize the value of firms in their portfolio as opposed to individual firm value.9 Another strand documents that board networks via interlocked directors are conduits for common behaviors across board-linked firms.10 We therefore expect common investor and board networks in a customer-supplier pair facilitate CSR propagation. In other words, when an investor of a customer firm subsequently also holds a stake in a supplier firm, or a director from the customer’s board thereafter also serves on the supplier’s board, such connectness allows the customer to wield influence. Our overall evidence that customers successfully influence suppliers’ decisions on better responsible business practices is consistent with this prediction.

Our findings, thus far, point to collaborative or cooperative CSR efforts along the supply chain, where suppliers are willing or are coerced to align their CSR standards with those of their customers. Such efforts perhaps reflect the fact that CSR decisions are not made in a vacuum but, rather, are made through an informed understanding of the benefits reaped and the costs incurred. We then proceed to examine the economic implications of these collaborative CSR efforts between customers and suppliers. Previous studies show value enhancements in corporations that implement CSR initiatives, such as issues related to human rights, the community, the environment, and the treatment of employees (e.g., Dowell, Hart, Yeung, 2000, Gillan, Hartzell, Koch, Starks, Edmans, 2011, Krüeger, 2015, Ferrell, Liang, Renneboog, 2016). However, implementing these CSR initiatives is costly and has negative financial implications (e.g., greater cost structure and agency problems) for their corporations (Balotti, Hanks, 1999, Masulis, Reza, 2015). Unlike these studies that focus on corporations’ own CSR activities and performances, our analyses look at the economic impact of collaborative CSR efforts of customers and suppliers through their alignment of CSR standards. The increase of collaborative efforts helps improve operational efficiency and firm valuation for both the customer and supplier but enhances only the customer’s future sales growth.

Our research makes two significant contributions to the literature. First, our research examines the role of a specific group of stakeholders—corporate customers—in propagating CSR along global supply chains, and shows evidence of a strong unilateral influence on CSR from the customer to the supplier only. While this evidence is interesting on its own, our study further shows that there are economic benefits associated with an improved CSR along the supply chain. A contemporaneous study by Schiller (2018) investigates whether a global supply chain acts as a mechanism through which CSR spills over from customers to suppliers. But his study looks at changes in regulation only on ESG disclosures, whereas ours utilizes both quasi-randomized and quasi-natural experiments on real ESG actions to establish the impact of customers’ voluntary rather than mandatory CSR practices on suppliers, and shows that shareholders’ proposals, expected product safety scandals, industry structure, and network connectedness all play a crucial role in propagating CSR. Our analyses offer new insights on how CSR gets transmitted around the world.

Existing studies attribute CSR to a firm’s strategic pursuit for superior financial performance (Flammer, 2015a), or a manifestation of agency problems (Masulis, Reza, 2015, Cheng, Hong, Shue). Recently, researchers began to investigate how a firm’s surrounding environment, such as national institutions (Ioannou, Serafeim, 2012, Liang, Renneboog, 2017) and interactions with other firms (Flammer, 2015b, Cao, Liang, Zhan, 2019), plays a role in CSR. However, little is known about how CSR is influenced by economically linked stakeholders. Our focus on an important type of stakeholders, namely, corporate customers, helps to reconcile some puzzles in the emerging CSR literature, especially why firms often engage in costly CSR activity. The fact that such activity is increasingly prevalent worldwide may be a result of forces by other market players, such as powerful customers. This is especially the case when societal demand for CSR becomes greater following numerous CSR-related scandals in recent years. Our findings not only enhance our understanding on what drives CSR but also, more generally, shed light on non-economic incentives and practices of modern corporations around the world.

Second, our research contributes to the understanding of how corporate policies and behavior spill over along global supply chains and the value implications of such spillovers. It also expands the supply chain literature, such as the spillover of corporate tax avoidance (Cen et al., 2017b), innovation knowledge transfers (Chu et al., 2019), and information diffusion along supply chains (Cen, Doidge, Schiller, Cen, Hertzel, Schiller; Dai et al., 2020). By focusing on international corporate customer-supplier relationships, our study joins this strand of literature and further demonstrates that some corporate behaviors, such as CSR, propagate unidirectionally across countries. These institutional and firm-level nuances are often overlooked in the extant literature.

Data and summary statistics

This study employs data from several different sources: (i) information on the global network of customer-supplier relationships from the FactSet Revere (‘Revere’) global supply chain data obtained through the Wharton Research Data Services (WRDS); (ii) information on firm-level CSR ratings provided by Thomson Reuters ASSET4 ESG (i.e., Environment, Social, and Governance) database, together with alternative ratings information from MSCI Intangible Value Assessment and Sustainalytics;

CSR and customer-supplier relationships

In this section, we examine whether corporate customers affect social and environmental engagements at their economically linked firms—the suppliers. Specifically, we investigate the CSR effect along the supply chain and determine whether any evidence of such effects depends on the locations of the customer and the supplier. We also conduct a host of additional tests to ensure robustness of our baseline evidence.

Identification strategies using quasi-randomized and quasi-natural experiments

Identifying the impact of customers on their suppliers’ future CSR performance poses an empirical challenge. The customer effect on supplier CSR might reflect the endogenous selection made by corporate customers. One might tackle this issue by examining the impact of government-mandated initiative or newly instituted country-level ESG regulation on CSR propagation in the supply chain. A critical problem with such approaches is that these regulatory outcomes typically bear different implications

The mechanisms

One key mechanism by which customers might influence a supplier’s CSR is through assortative matching. For example, customers with high CSR are more likely to select suppliers who will meet their expectations of socially responsible behavior. Alternatively, it is also possible that the customers actively push suppliers to get more involved in CSR and embrace it. In this section, we examine these two possible avenues.

Economic consequences of customer effects of CSR

In the preceding sections, we have shown that customers have a positive impact on suppliers’ CSR practices, suggesting that suppliers do respond to their customers and behave similarly in socially responsible ways. However, a question that remains is whether there is any economic benefit arising from customers pushing suppliers for greater social responsibilities.

Existing studies dispute whether the benefits of CSR outweigh its costs. Some studies find that CSR initiatives can help firms build

Conclusion

Many large corporate customers around the globe increasingly recognize the importance of integrating social responsibility initiatives into their business model to build a sustainable competitive advantage in the marketplace. However, the impact of their power as customers to drive improvements in responsible business practices through their global supply chains has not been widely studied. Our research exploits several unique international databases to examine whether and how their large

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