Second- versus Third-party Audit Quality : Evidence from Global Supply Chain Monitoring

To capitalize on the superior credibility and flexibility and lower cost of external assessments, many global buyers are shifting from using their own employee (“second-party”) auditors to relying more heavily (or entirely) on third-party auditors to monitor and prevent environmental and social misconduct in supply chains. This trend is supported by ingrained assumptions about auditor incentives; namely, that third-party auditors’ greater independence reduces bias and improves audit quality. However, some are concerned that this trend risks eroding audit quality. Drawing on agency theory to provide a more nuanced understanding of auditor incentives and data from a leading global fashion brand, we find such concerns warranted: third-party auditors are less effective at citing violations at a given factory than second-party auditors, especially as the factory’s region exhibits more reported corruption or less potential oversight by second-party auditors. Global buyers can bolster third-party-audit quality by increasing the presence of second-party auditors in a given region, emphasizing such deployments in more corrupt regions, and rotating among different third-party audit firms. Our findings can inform better-designed monitoring not only of suppliers, but also of other business partners that create risks for brands, such as franchisees, distributors, vendors, and purchasing agents