Suppliers increasingly face customer pressure to decarbonise. However, there’s no empirical evidence that firms can lead their suppliers to reduce emissions. The adoption of targets doesn’t change much because emissions and energy inputs are inherent to production technology and substantial changes may take time. Swarnodeep Homroy and Asad Rauf write that suppliers make symbolic commitments to sustainability in the absence of legal frameworks for fair pricing and environmental audits.
In recent weeks, a climate disclosure rule by the US Securities and Exchange Commission (SEC) has been a hot topic of debate in legal and political circles. The proposed requirement for companies to report the climate impacts of their suppliers, which the SEC eventually dropped, has been a lightning rod. The underlying idea is that, in a global production network, US corporations can spearhead the emission abatement initiatives of their suppliers, thereby reducing climate risks for their investors and advancing the global decarbonisation agenda.
Regulators in the US and the EU have shown increased urgency to hold firms accountable for the climate impact of their supply chains. The detractors of these regulations claim that these policies will lead to superficial “greenwashing” initiatives and burden firms with onerous compliance requirements. This debate is difficult to resolve because the assumption that firms can lead the emission reduction initiatives of their suppliers is backed by very little empirical evidence. Do suppliers take the lead from customer firms and adopt climate-responsible policies? Will such adoptions ultimately lead to lower emissions at supplier sites?
Our latest research addresses these questions using detailed disclosure of corporate climate action and climate governance practices of a global sample of firms. Climate resilience in supply chains is a salient issue because environmental protection and natural resource management problems occur across international borders, making it difficult for any single government to regulate.
Some recent studies have indicated that large American firms are reshaping their supply chain, moving away from “brown” and towards “green” suppliers when confronted with high climate risk. This shift can help reduce physical risk, but corporations still grapple with the challenge of making the rest of their existing suppliers more sustainable. Crucially, firms incur relationship-specific investments with their suppliers, and therefore, replacing suppliers en masse can be prohibitively expensive. Therefore, the evidence on suppliers’ decarbonisation practices is important to evaluate the likely efficacy of supply chain sustainability initiatives.
Our findings reveal a significant trend: suppliers increasingly face customer pressure to decarbonise. For instance, in 2011, only a quarter of suppliers faced customer emission-reduction pressure, but this figure increased to over 80 per cent by 2020 (Figure 1), with some industry variation. In response to this mounting pressure, suppliers have also begun to adopt emission-reduction targets, marking a significant shift in their climate-responsible policies. These adoptions are more likely when customer firms have higher bargaining power over suppliers.
Figure 1. Fraction of firms facing customer emission-reduction pressure (2011-2020)
However, these adoptions don’t translate to changes in emissions and energy inputs. It is difficult to draw a strong inference about climate outcomes from these results alone because emissions and energy inputs are inherent to production technology, and substantial changes may not happen in the short run. Then we seek to detect whether suppliers change their operating activities, which can lead to lower emissions in the long run. We find no evidence that suppliers’ adoption of emission reduction targets is associated with an increase in the leading indicators of emissions abatement, such as capital expenditure and research and development (R&D) expenses. We call this the policy-outcome gap.
Do our results suggest that supply chain sustainability is rife with greenwashing, as the detractors of the SEC’s proposal claim? Further analyses suggest that the story is more nuanced. Suppliers with higher financial margins, a key factor in their ability to invest in green technology, increase their investment after they adopt emission-reduction targets following customer pressure, even though emissions do not fall in the short run. This is also the case for suppliers geographically close to customer firms, which facilitates better monitoring of their climate actions. Therefore, the policy-outcome gap is smaller if suppliers retain a larger fraction of their revenues or can be better monitored by customer firms.
These are important results because large-scale reconfiguration to build climate resilience will likely be at the cost of economic resilience. Replacing the stock of suppliers with more sustainable suppliers will likely increase prices, reduce productivity and lower competitiveness. If customer firms can lead the adoption of climate-responsible policies to existing suppliers, then such a ‘climate resilience-economic resilience’ trade-off can be less binding. These results also shed light on the economic origins of greenwashing concerns related to supply chains.
Our results underscore features of the current generation of supply chain climate disclosure regulations that are likely to render them ineffective. Regulators worldwide increasingly focus on corporate environmental due diligence to identify, prevent, and address environmental violations within their and direct suppliers’ operations. In response to these policies, customer firms will likely cascade these pressures upstream through bilateral private regulations of suppliers’ environmental standards and climate policies. Since writing explicit contracts on short-term environmental outcomes is hard, customer firms typically write clauses that limit their legal liabilities and indemnify the suppliers in the event of an environmental scandal.
Such governance by exit strategy may insulate the customer firm from stakeholder pressure without improving global climate outcomes. A survey of sustainability practices of automotive, electronics, and pharmaceutical industries confirms that many suppliers violate the required sustainability standards of these private regulations, even though they often comply on paper. Respondent suppliers of this survey highlight that slim profit margins and lack of oversight contributed to symbolic engagements.
An alternative approach is for customer firms to invest in developing the environmental capabilities of suppliers. However, it is costly for the customers to collect, monitor and develop climate-impact of suppliers. Therefore, future generations of public policies on sustainable supply chains must incentivise a shared responsibility approach to contracting. Many academics and legal scholars, such as those in the Responsible Contracting Project, have urged regulations combining climate due diligence requirements with economic incentives. These regulations must incentivise suppliers and consumers to invest in monitoring and developing climate-resilient production technology. With strong incentives to offer better prices to suppliers and monitor their climate-responsible practices, large firms’ adoption of climate-responsible practices can trigger multiplier effects in the global decarbonisation drive.
- This blog post represents the views of the author(s), not the position of LSE Business Review or the London School of Economics and Political Science.
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