Cooperative Approaches to Managing Social Responsibility in a Market with Externalities

The incidents of safety, labor and environmental violations in recent years have compelled many firms to rethink their approaches to managing suppliers. This paper investigates two cooperative approaches that are used in practice: auditing a common supplier jointly ("joint auditing") and sharing independent audit results with other firms ("information sharing"). We develop a model based on a cooperative game in partition function form that captures both competitive and cooperative interactions among firms. Our analysis shows that, although there has been some concern about cooperation for fear of compromising a competitive advantage, firms have incentives to cooperate in managing their suppliers when the negative externality of one firm's social responsibility violation on other firms is high. However, when the negative externality is low, firms do not have incentives for joint auditing (unless audits are very costly), nor do they have incentives for information sharing. Our analysis further reveals that, contrary to common belief, neither cooperative approach necessarily improves social responsibility, especially when one firm can benefit from others' social responsibility violations (i.e., the positive externality is high). This is because cooperation reduces competitive intensity among firms, who then underinvest in audits under the high positive externality. Finally, even if agreement is not reached for cooperation before conducting individual audits, social responsibility can still be improved by incentivizing firms with better information to share their private information with others. To facilitate such ex-post cooperation, we propose a profit-allocation scheme among firms, and specify the amount of subsidy a third-party organization should provide