Firm-Level Experiment on Sanction Compliance and Supply Chain Partner Choice

• In Event: Economic Sanctions and Global Business

Abstract

What factors influence firms’ perception of sanction risk? Conditional on coercion being the objective for the sanction-sending state, economic sanctions are only effective if they could be both credibly applied and lifted. Although the authority to impose economic sanctions rests solely with the state actor, sanctions are carried out primarily via private entities - multinational corporations (MNCs). This means that the sanctioning state needs to convince firms to refrain from engaging economically with the target state when it imposes sanctions and, equally importantly, to restart economic relations with the sanctioned state after sanctions have been lifted. Failure to do so could lead to less credible sanction threats and impositions in the future. Conversely, companies that are not specifically targeted by sanctions may still choose to curtail operations in the targeted state. Both over- and under-compliance by firms could result in the less than optimal use of sanctions. However, what leads to both is not well-studied in the literature.

We posit that risk perception is key to explaining corporate sanction compliance behaviors. We conceptualize firms as independent strategic actors and argue that risk perception shapes firms’ utility functions in important ways. The less risk averse a firm is when it comes to sanction compliance, the less heavily it discounts uncertain future punishment from the sanctioning state and vice versa.

We focus on organizational risk perception, defined as tolerance for potential negative financial consequences resulting from continuation of sketchy business operations. It is an outcome of careful strategic planning and managerial procedures that motivate corporate choices. Indeed, as sanction enforcement agencies embrace private self-regulation in sanction compliance, the primary goal is to reduce organizational risk perception so that every staff is aware of potential risks of business operations, and firms overall become more “responsible” corporate citizens.

The choice of supply-chain partners is a good measurement of a firm’s organizational risk perception. Sanctions enforcement targets transactions with sanctioned entities. As the term “transaction” is deliberately defined broadly, any business dealing with a potentially sanctioned supply-chain partner–from the trading of goods and services to the use of platforms–can constitute violations of sanctions. Thus, the choice of supply-chain partners is a serious business decision that could have long-term repercussions if not managed carefully. We hypothesize that the decisions on supply-chain partners are affected by dimensions such as the potential partner’s home country, its past history of sanction violations, the industry/sector it operates within, and whether and where it has subsidiaries or branches.

To empirically examine what factors drive firms’ sanction risk perception, we utilize a firm-level survey experiment distributed in collaboration with several chambers of commerce in the US. We first determine the survey respondent’s sanction risk tolerance level. Then, through a conjoint experiment we manipulate different dimensions that are potentially linked to business risk calculations and ask how likely the corporate respondent is to form transactional relations with the hypothetical partner. Our experiment contributes to our understanding of firm-level heterogeneities in sanction compliance considerations.

Authors

• Pei-Yu Wei, UT Austin

• Zhizhen Lu, University of Texas at Austin