Big customer is watching you: why regulating corporate conduct works

Some of the most damaging corporate scandals of recent years have emanated not from within the walls of big-name companies, but from their supply chains.

Apple and other tech giants were criticised for their links to Foxconn, the electronics maker at which many workers in China died by suicide due to dire working conditions. Several large retailers including Walmart and Benetton faced scrutiny following the high-profile Rana Plaza disaster in Bangladesh, where a building housing several garment factories collapsed, killing hundreds of workers. Marks and Spencer, Disney and others have been called out for polluting practices of the companies that made textiles and toys for them.

The reputational hit wrought by such misdemeanours means that large, prominent companies have become more vigilant about identifying, preventing and mitigating corporate violations among their suppliers. Over the last decade or so, they are also starting to be held legally responsible for the behaviour of their suppliers through various pieces of legislation, such as the Modern Slavery Act in the UK and the EU Corporate Sustainability Due Diligence Directive.

Legislation typically takes aim at large companies in the hope of creating a positive ripple effect on the smaller companies that supply them. Does this approach work? Our research suggests that it does.

The power of a big customer

Our study found that scrutiny by large companies of their suppliers has a significant upstream effect, with the desired result of reducing corporate misconduct. We examined 1,496 publicly listed firms in the US found to have committed any corporate misconduct from 2000 to 2022. These offences ranged widely, from workplace health and safety to environmental violations and consumer protection issues.  

Firms with at least one major customer – meaning one that accounted for 10% or more of revenue – were associated with fewer and less severe violations. That trend held across industry, company size and violation type.

To test our hypothesis further, we measured the effect of a firm establishing a relationship with a major customer for the first time. We found that there was a decline in misconduct within that company after it established a major customer relationship. What’s more, we found that in the years immediately before taking on a first major customer, corporate misconduct was reduced, suggesting that companies are under pressure to tighten up their own monitoring if they want to supply to big companies.

Another clue that reputational risk is a powerful motivator for big companies was that the major customers of the firms we examined only responded to high-profile violations that resulted in the steepest fines, such as serious environmental damage. We found that only severe violations led to punishment – contract termination, for example – by major customers. When we examined the effects of violations with low penalties – those less likely to attract public attention and therefore cause reputational damage – there was no significant drop in major customers or company performance.

This research adds to evidence of the important role of market-based mechanisms for disciplining corporate misconduct. Studies have shown that companies face punishment by investors, employees and the marketplace for committing violations. Sometimes the financial ramifications caused by these parties exceed the legal penalties for misconduct. 

Why bigger is better

Big-name companies are highly motivated to discipline suppliers because they themselves tend to take the heat in major corporate scandals. They also have the means.

First, big companies have the resources to monitor and scrutinise their suppliers. The more they put those resources to use, the greater the deterrent effect. We found that suppliers who faced enhanced scrutiny from customers for a variety of reasons – a recent corporate scandal in the news, a recently appointed CEO, or because of board member overlap – were better behaved.

Second, they can impose a heavier punishment for bad behaviour, creating a natural incentive among suppliers with major customers to embrace monitoring and self-discipline. In our study, firms with major customers incurred greater costs following high-penalty violations than those with diffuse customer bases. We also found that there was less supplier misconduct when the customer could more easily switch to a competitor, highlighting the powerful deterrent effect of losing an important customer.

What can policymakers and regulators learn from this study?

1. Regulation has a wide reach: Imposing harsher regulations on large companies has a cascading effect on smaller firms across the supply chain, even those in different jurisdictions.
    
2. Market mechanisms do work: The customer-supplier relationship is an example of a market-based mechanism that can be used to discipline companies and disincentivise bad behaviour.
    
3. Reputational risk is a powerful incentive: Large companies are strongly motivated by reputational risk, so dissemination of information about corporate misconduct is a powerful way to increase the major customer deterrent effect.
    
4. Large customers benefit markets: Customer concentration is often framed in terms of economic risks, but large customers bring benefits as well, as they are more effective than smaller ones at deterring misconduct.

Read the article: “Do Major Corporate Customers Deter Supplier Misconduct?” Jie Chen (Leeds University Business School, University of Leeds), Xunhua Su (Norwegian School of Economics) Xuan Tian (Tsinghua University) Bin Xu (University of Reading) and Luo Zuo (National University of Singapore) Journal of Accounting and Economics Volume 80, Issues 2-3, 2025. 101801, ISSN 0165-4101