Monitoring the Monitors

The following post comes to us from Jodi Short, Professor of Law at the University of California Hastings College of the Law; Michael Toffel of the Technology and Operations Management Unit at Harvard Business School; and Andrea Hugill of the Strategy Unit at Harvard Business School.

Drawing on insights from the literatures on street-level bureaucracy and on regulatory and audit design, our paper, Monitoring the Monitors: How Social Factors Influence Supply Chain Auditors, which was recently made publicly available on SSRN, theorizes and tests the factors that shape the practices of private supply chain auditors. We find that audits are conducted most stringently by auditors who are experienced and highly trained, and by audit teams that include female auditors. By contrast, auditors that have ongoing relationships with audited factories, and all-male audit teams conduct more lax audits, identifying and citing fewer violations. These findings make five key contributions and suggest strategies for designing audit regimes to more effectively detect and prevent corporate wrongdoing.

First, we significantly extend knowledge about compliance auditing by looking beyond economic conflicts of interest to the broader array of social institutions, identities and relationships that shape the way auditors enforce the rules. We find that financial conflicts of interest are indeed associated with more lax enforcement by auditors. But our finer-grained analysis suggests that audit designers might reduce bias and thereby increase audit reliability by considering the auditors’ characteristics and relationships that we found to significantly influence the stringency of audit teams. These findings can likewise inform those interested in other types of private gatekeepers such as accountants and credit rating agencies, subjects of much interest since their failures to detect and reveal corporate wrongdoing led to corporate scandals and financial meltdowns in the early twenty-first century. The gatekeeper literature, like the auditing literature, has focused almost exclusively on the influence of economic conflicts of interest. Our study suggests the need not only to attend to economic conflicts of interest, but also to look at a broader array of social and relational factors to structure more effective gatekeeping regimes.

Second, we initiate a productive dialogue between literatures on public sector and private sector monitoring regimes. To date, calls for insight into the micro-level processes of private supply-chain auditing have overlooked the extensive research on street-level policy implementation by government monitors, while street-level bureaucracy research has largely ignored the private-sector monitors who play an increasingly important role in implementing standards governing corporate conduct. Our study connects and extends both literatures by elaborating micro-level policy implementation practices in the context of private sector auditing.

Third, we contribute to the literature on transnational business regulation. Supply chain auditing has become an important component of international regulatory strategies that seek to address the social and environmental risks of business activities beyond the reach of state governments. Private (non-governmental) regulations and labeling regimes such as the Forest Stewardship Council, the Marine Stewardship Council, and Fair Trade rely on private third-party auditors. International intergovernmental institutions such as the United Nations have encouraged supply chain auditing by requesting that companies conduct “due diligence” to ensure their suppliers’ compliance with international human rights norms, and many national regulators have followed suit—sometimes also requiring MNCs to monitor and disclose supply chain practices. The efficacy and legitimacy of these efforts largely depends on the credibility of monitoring. While our findings of auditor heterogeneity may call into question auditor independence and objectivity, our identification of several systematic determinants of that heterogeneity suggests how companies and policymakers can improve audit validity.

Finally, our findings have important implications for those who design auditing regimes and the corporate managers who hire them. For example, our finding that financial conflicts of interest are associated with more lax enforcement by supply chain auditors empirically supports arguments that auditors should not be paid by the organizations they audit. Our finding that auditors tend to cite fewer violations at factories where they have ongoing relationships empirically supports auditor rotation policies to prevent capture by long-term clients. Our findings also highlight the importance of training for private-sector monitors. While auditors with higher educational credentials did not find significantly more violations than less educated peers, those with more audit-specific training did. Finally, our findings suggest that audit teams are more effective when they include more experienced auditors and female auditors, suggesting the need for due consideration of these factors when composing audit teams.

By providing the first comprehensive and systematic findings on supply chain auditing practices, our study suggests strategies for designing more credible monitoring regimes.

The full paper is available for download here.


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