Supplier Evasion of a Buyer ’ s Audit : Implications for Auditing and Compliance with Labor and Environmental Standards

Deadly factory fires. Illegal pollution. Injured workers. Many brands have recently been tarnished by publicity of suppliers’ labor and environmental violations, and have responded by increasing their auditing efforts. Anecdotal evidence suggests that “hiding”—supplier efforts to pass an audit through deception or corruption—is prevalent. Under that condition, we show analytically that increasing auditing backfires by increasing hiding effort and reducing a supplier’s effort to comply with labor and environmental standards. Similarly, increasing a supplier’s margin (by paying a higher price or providing training that improves its productivity) promotes hiding and reduces compliance effort. Increasing effort by NGOs to publicly expose violations also does so. To promote compliance, NGOs and buyers should instead collaborate to make hiding more costly and difficult for suppliers. More generally, we provide guidance for a buyer on how the optimal level of auditing varies with a supplier’s hiding and compliance capabilities, both firms’ contribution margins, the likelihood that an NGO will publicize a violation, and other salient aspects of the business environment.