SEC’s Climate Disclosure Rule wouldn’t have led to Sustainable Supply Chains

In recent weeks, the Securities and Exchange Commission’s (SEC) Climate Disclosure Rule 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 emission abatement initiatives of their suppliers, thereby reducing climate risks for their investors and advancing the global decarbonisation agenda. This idea, however, 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?

In our new research, we provide answers to these pressing questions using granular firm-level data on disclosures on corporate climate action and climate governance practices of a global sample of firms. Our findings reveal a significant trend: suppliers are increasingly facing pressure from customers to decarbonise. For instance, in 2011, only a quarter of suppliers faced emission-reduction pressure from customers, but this figure has increased to over 80% by 2020. In response to this mounting pressure, suppliers have also begun to adopt emission-reduction targets, marking a significant shift in their climate-responsible policies. However, these adoptions don’t translate to changes in emissions and energy inputs or leading indicators of abatement such as capital expenditure and Research & Development 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 results of our research 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 proximate 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.

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 own and their 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, this 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 incentivize a shared responsibility approach to contracting. Many academics and legal scholars, such as those in the Responsible Contracting Project, have urged that regulations combine climate due diligence requirements with economic incentives. Regulation can incentivize suppliers and consumers to invest in monitoring and developing climate-resilient production technology.

Swarnodeep Homroy is a Professor of Finance at the University of Groningen.

Asad Rauf is a Professor of Finance at the University of Groningen.