The rising tide of environmental, social, and governance (ESG) awareness among many stakeholders is reshaping the corporate information environment. These stakeholders, driven by a desire for transparency, are demanding more detailed ESG-related information to evaluate corporate practices better. However, one significant limitation is the inconsistency in ESG disclosures among different jurisdictions regarding measurement, scope, and the overall requirements for reporting. Given these discrepancies and the lack of stringent systems to monitor and enforce ESG information disclosure across countries, our research focuses on the potential ramifications of mandatory ESG disclosure regulations on firms’ global supply chain decisions.
Why Supply Chain Decisions?
Previous research flags an alarming trend that current ESG reporting standards often overlook the sustainability-related actions within a firm’s supply chain. To elucidate, multinational corporations have, on occasion, turned a blind eye towards sourcing from regions notorious for poor working conditions in a bid to cut labor costs. Additionally, supply chain decisions intersect with environmental concerns, especially when outsourcing leads to escalated pollution.
The Pressures of Mandatory ESG Disclosures
Firms could react in three ways regarding their supply chain decisions in response to mandatory ESG disclosures. Some might revamp their supply chain to minimize ESG-related risks, especially if switching costs are minimal. They could either opt for suppliers located in jurisdictions that require ESG disclosures, which would result in more informed supply chain decisions considering ESG-related risks. Alternatively, they may opt for suppliers from regions with lax ESG disclosure requirements, thus complying with the ESG disclosure mandates but effectively not factoring in ESG-related considerations in their supplier decisions. Another possibility is that switching costs due to mandatory ESG disclosures may be so high that firms keep their existing supplier relationships. Under such circumstances, if mandated ESG disclosures pressure firms, they may also influence their existing suppliers to adhere to higher ESG standards (Dai, Liang, and Ng, 2021).
Main Findings
Based on supply chain data of 22,400 global firms spanning 2003 to 2019, we observe shifts in firms’ supply chain compositions following the introduction of mandatory ESG disclosures. Our empirical strategy is based on a differences-in-differences design that exploits the staggered implementation of mandatory ESG disclosures in different countries. We compare changes in supply chain configurations among firms that became subject to mandatory ESG disclosure requirements to firms in countries without such requirements at the same point in time. Our analyses suggest that mandatory ESG disclosures push firms to reconfigure their supply chains to benefit from regions without mandated ESG disclosure guidelines. We find supporting evidence that companies do so by reducing the proportion of domestic suppliers and increasing suppliers from countries without rigorous ESG disclosure norms.
Additionally, our findings suggest that several factors can mitigate firm incentives to alter their supply chain configurations in response to pressures from mandated ESG disclosures. For example, mandatory ESG disclosures that incorporate specific guidelines concerning supply chain diligence processes appeared to mitigate such evasive behaviors. Furthermore, we document that heightened ESG awareness by stakeholders, rigorous analyst scrutiny, and larger institutional ownership can act as effective corporate governance mechanisms, reducing the propensity of firms to shift their ESG responsibilities to less transparent suppliers. In additional analyses, we show that this change in supply chain configurations is “strategic,” stemming from pressures associated with the ESG disclosure mandates and not solely motivated by cost efficiencies.
Implications
Our study has implications for the effectiveness of regulatory governance mechanisms in disciplining firms’ ESG performance. While most studies have focused on either firm-level and/or national-level measures to promote enhanced ESG commitment by firms (e.g., board structure, executive compensation design, disclosure regulation, etc.), our study highlights the potential limitations of such governance mechanisms. Supply chain practices have long been a contentious issue for evaluating firms’ ESG performance, with only limited success in enforcing sustainable practices as supplier relationships frequently transcend the traditional legal boundaries of the firms. This study sheds light on the need for a more global, collective approach toward introducing regulations to enhance ESG performance, especially in today’s business environment where firm operations critically hinge on global supply chain networks.
Our findings highlight that mandated regulatory efforts in one jurisdiction can have significant spillover effects on other countries due to complex global supply chain configurations. Firms tend to adjust their supply chain composition, opting for suppliers in regions with less stringent ESG reporting standards and decreasing their reliance on domestic supplier relationships subject to the same ESG disclosure mandates. This highlights the interconnectivity of supply chains across borders and the need for a comprehensive, cross-border approach to address ESG concerns in the global business landscape.
Hai Lu is the McCutcheon Professor in International Business and a Professor of Accounting at the University of Toronto, Canada.
Jee-Eun Shin is an Assistant Professor of Accounting at the University of Toronto, Canada.
Qilin Peng is an Assistant Professor of Accounting at the University College Dublin, Ireland.
Luping Yu is an Assistant Professor of Finance at Xiamen University, China.
This post was adapted from their paper, “Migration of Global Supply Chains: A Real Effect of Mandatory ESG Disclosure,” available on SSRN.
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