Regulatory Costs and Vertical Integration: Evidence from Supply Chain Disclosure Regulations

Author: Enshuai Yu

Abstract

I study whether and how supply chain disclosure regulations shape corporate boundaries, particularly, vertical integration decisions. I employ a2 010 California disclosure mandate for firms’ efforts to eradicate human trafficking and slavery in supply chains. I hypothesize that by imposing potential costs on focal firms including litigation risk, reputational costs, and supply chain information acquisition and monitoring costs, this disclosure regulation shifts cost-benefit tradeoffs of firms’ make-or-buy decisions and incentivizes firms to enhance vertical integration within supply chains. Difference-in-differences analyses demonstrate that following the regulation, treated firms make more vertical acquisitions, especially upstream, relative to control firms. The effect is concentrated among firms facing greater stakeholder pressure (e.g.,plaintiffs, consumers, NGOs, and shareholder activists) and firms with higher sourcing risk or asset specificity. Also, following the regulation, treated firms increase overall vertical integration and reduce outsourcing to suppliers. In addition, treated firms exhibit more voluntary disclosure of vertical integration activities, business segments, product similarity to upstream firms, and strategic alliance activity. Collectively, my findings suggest that supply chain disclosure regulations incentivize firms to become more vertically integrated within supply chains.