Alminas Žaldokas | The Impact of ESG on Global Supply Chains

At the start of the lecture, Aminas first introduced recent regulatory policies in the United States and European countries. In March 2022, the U.S. Securities and Exchange Commission (SEC) proposed an amendment requiring publicly traded companies to disclose indirect greenhouse gas emissions, or Scope 3 emissions, occurring in their upstream and downstream supply chain activities. This means that up to 90% of carbon dioxide emissions may originate from the industries of their suppliers; however, measuring Scope 3 emissions covering the entire supply chain is extremely difficult.

He mentioned,Draft of the European Commission's Due Diligence Directive on Corporate Sustainability (i.e., the EU Due Diligence Act)RequireCompanies are conducting in-depth due diligence across their global supply chains.Disclose the negative impacts on the environment and other aspects.The draft applies to both listed and unlisted companies, as well as EU companies and non-EU companies operating in the EU.also,Germany has officially passed the German Supply Chain Act.。

Therefore, companies face ongoing regulatory challenges in monitoring and controlling the environmental and social performance of their suppliers, especially after regulators develop and implement regulations requiring companies to manage environmental and social risks associated with their suppliers. How will companies respond? When companies learn that their suppliers are not complying with expected environmental and social standards, they can improve overall supplier performance by working with suppliers to adjust their operations (participation mechanisms) or by replacing suppliers involved in environmental and social incidents (exit mechanisms). So, can companies achieve self-regulation through exit mechanisms?

Against this backdrop, Aminas and its collaborators sought to study different externalities in global supply chains and understand how client companies select suppliers in different economies. For example, how US client companies consider environmental and social factors when choosing foreign suppliers, particularly in Asian economies. They focused on three key questions: first, whether client companies would significantly reduce trade when suppliers become involved in environmental and social events; second, whether trade reductions are driven by non-monetary preferences of stakeholders (e.g., environmentally conscious investors or consumers); and third, whether exit mechanisms are effective and can incentivize suppliers to improve their ESG performance.

Aminas stated that they matched these environmental and social events involving foreign suppliers with U.S. companies' ocean freight import data to study trade changes surrounding supplier events and further analyzed the long-term impact on U.S. customer companies and foreign suppliers.

The research results indicate that, firstly, when suppliers are involved in environmental and social events, client companies' imports from them decrease by 30%, and the likelihood of trade relations terminating increases by 4.3%. Client companies are more inclined to choose new suppliers from other countries or suppliers with higher ESG ratings.

Secondly, during periods of heightened environmental awareness, environmental and social events have greater externalities and a greater impact on suppliers, leading to larger trade reductions. Furthermore, for the same event, the trade reductions will be even greater when client companies are more likely to face pressure from environmentally conscious investors.

Third, under the exit mechanism, smaller individual suppliers are more likely to improve their ESG ratings after trade reductions; trade will recover after both trade reductions and rating improvements. Overall, firms will take costly actions to cater to non-monetary preferences, such as investors' ESG preferences.

Aminas argues that this article enriches the literature on how environmental and social factors influence global supply chain structures. Existing literature focuses on issues such as "how suppliers can better match with customer companies," "whether changes in customer companies' environmental policies trigger corresponding policy changes in downstream suppliers," and "pollution outsourcing." This article, however, is the first to conduct a large-sample study on trade reductions following suppliers' involvement in environmental and social events, and proposes a governance approach through exit mechanisms, suggesting that trade reductions can incentivize suppliers to comply with ESG standards.

On the other hand, this article enriches the research on "institutional investors' oversight of firms' environmentally and socially friendly activities." Existing literature focuses more on the direct impacts of environmental and social events than on their actual impact on trade and their potential impact on inter-state trade. This article is the first to examine how institutional investors' consumption preferences influence trade activities with suppliers and the structure of global supply chains, and to investigate the indirect constraints imposed on client firms by exit mechanisms.

In closing, Aminas concluded that U.S. companies' governance of their suppliers' environmental and social activities (through exit mechanisms) is effective in certain circumstances, particularly when facing greater investor pressure. The widely discussed Scope 3 emissions disclosure requirements can help investors gather more information about a company's supply chain environmental performance and, if necessary, exert pressure, thereby helping the government better implement policies. He stated that future research will explore whether the damage to international customer businesses and reputations caused by high-profile environmental and social scandals would also prompt exporting countries to introduce new regulations.