Responsible Sourcing Under Supplier-Auditor Collusion

Abstract

Problem definition: Although they enjoy 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 a 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 an 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 trade-off between a third-party audit and an in-house audit, we offer explanations for why many global brands fully rely on third-party audits and set higher process quality requirements for suppliers located in high-risk countries. The robustness of our insights is 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 penalties and to promote the ethical level of the third-party auditors located in high-risk countries.