The implications of 'high-road' vs. 'low-road' employment practices

The human consequences are unacceptable to leaders in a wide range of companies, and yet socially irresponsible business practices have persisted even after buying organizations committed to root it out of global supply chains. Image: Shutterstock

Despite a notable uptick in socially-responsible behaviour by corporations in recent years, irresponsible employment practices remain all too common.  The challenge is especially difficult for firms that source products from overseas.  Many large corporations, themselves committed to social responsibility,  purchase inputs in emerging-markets from small manufacturers that engage in practices that expose employees to harm.

One of the most widespread practices is wage theft, whereby employers deny earnings and benefits that workers are owed. At the more extreme end of the spectrum, factory workers have been enslaved (e.g. by Nestle’s seafood suppliers in Thailand) and subjected to compulsory political and religious indoctrination (e.g. by suppliers to Adidas, H&M and Nike in China). When the Fair Labour Association audited the China operations of Foxconn, one of the world’s largest manufacturers and exporters of electronics, it found that 14 per cent of workers had experienced some form of wage theft, even after the company’s practices had supposedly been improved in the wake of a series of worker suicides.

The human consequences are unacceptable to leaders in a wide range of companies, and yet socially irresponsible business practices have persisted even after buying organizations committed to root it out of global supply chains.   In our research, we sought insights regarding why the practices are so entrenched, and what the leaders of global multinationals can do to get suppliers off a low road and onto a high road in their treatment of workers.  In this article we will summarize the findings of our research, recently published in Organization Science, and the implications for corporations that do business in emerging markets.

Irresponsible Employment Practices

An extensive body of research has linked human resource management (HRM) practices to a wide range of organizational outcomes, including productivity, wages, employee turnover and profitability.

However, this research has largely focused on positive HRM practices such as decentralizing discretion to frontline employees, enhancing skill levels and rewarding performance. Commonly studied practices have ranged from self-directed teams to job rotation programs and performance-based pay. Many of these practices appear to be complementary to one another and together create ‘high involvement’ and ‘high performance’ work cultures.  

Far less research has been conducted on how HRM practices that take away from employees influence organizational outcomes. Consider wage theft—defined as denying workers wages or benefits that the employer is contractually or legally obligated to provide. This practice may sound foreign to some, but it is remarkably common, even in advanced economies. Recent surveys in the U.S. and Australia show that large numbers of low-wage employees are exposed to this practice.

Wage theft is widespread in emerging market countries.  Journalists and activist organizations have repeatedly alleged systemic underpayment of wages in emerging-market factories and farms that supply multinational corporations. Wage theft is just one of many socially irresponsible practices that are prevalent in low-income countries. Others include excessive and involuntary overtime work and punitive workplace discipline measures.

Prior research on socially-irresponsible employment practices has focused primarily on its causes rather than on the way that these practices are connected broadly to the performance and product characteristics of suppliers. Explanations include lack of economic opportunity, lax regulatory enforcement, and global economic pressures that depress wages in low-income countries. For many economists, poor wages and working conditions are primarily a function of the low productivity of labour. The assertion is that, as economic growth leads to higher levels of labour productivity, poor conditions will naturally disappear.

At the same time, previous research suggests that a great deal of variation in HRM practices and social responsibility is explained by firm-level factors: Within the same economic and institutional contexts, some manufacturers engage in harmful employment practices, whereas others do not.

Also read: Why pay inequality could grow in coming years

Stakeholder Theory and Value Creation

Stakeholder Theory has become substantially more precise in recent years by examining how firms create value and how the allocation of that value among contributing stakeholders occurs. This literature holds that each stakeholder that contributes to value creation within a firm compares the return from the investment of effort and other resources to outside alternatives. Firms are successful at retaining stakeholders such as employees when these stakeholders anticipate more gains from working at the firm than from pursuing alternatives.

The stakeholder management literature also emphasizes that the value that an employee contributes to the firm depends on the stakeholder’s human capital, which may be fully specialized to the
firm, partly specialized to the firm, or generally valuable to multiple employers.

Fully and Partially specialized human capital. Fully firm-specific human capital arises, for example, when a worker is trained to operate, maintain, or repair a piece of equipment that is unique to the employer. Partially firm-specific human capital arises when a worker is trained in tasks that are not fully unique to the firm, but which are tailored at least in part to the needs of the firm rather than to the needs of alternative employers. For example, a worker who has been trained in planning, accounting, and/or measurement tasks may have skills that are partially but not fully transportable to alternative employers.

When a worker develops skills that are partially but not fully specialized to the employer, a tension arises for the employer: The worker has skills that are marketable to alternative employers through voluntary departure from the firm. At the same time, because the worker’s human capital is more valuable to the original employer than to an alternative employer, the worker has the potential to capture more value by continuing to work for the original employer. Any action by the original employer that depletes the value that the worker attaches to their job may provoke the worker’s voluntary departure.

Generally valuable human capital. In some cases, workers may acquire general human capital, such as the ability to read or perform computations, that is equally valuable to alternative employers.

In the manufacturingtings we analyzed, all three types of human capital arise.

Trade-offs arise for firms in seeking to engage and retain a specific stakeholder such as an employee. Stakeholders that develop substantial firm-specific human capital may greatly enhance the value that the firm creates, but, at the same time, these stakeholders can appropriate a great deal of that mutually created value by threatening departure or underinvestment in the future. In contrast, workers that do not develop firm-specific human capital are easier to replace and more likely to accept low wages.

According to one theory, firms may be disinclined to direct payments to stakeholders—for example, by paying only market wages to low-income workers—when such workers are relatively abundant and are straightforward to replace due to their lack of human capital. In contrast, other firms may promote ‘appropriability regimes’ in which workers receive specialized training, are sought for retention, and are paid more than the market wage for untrained, unspecialized workers (because the firm creates more value by retaining workers with relevant skills than it would if the workers were not as skilled.)

Researchers in the fields of Industrial Relations (IR) and HRM have grouped these practices as ‘low-road’ and ‘high-road’ employment practices. One study looked at relationships between employment practices and organizational performance in call centres, finding that greater employee engagement in decision-making, on teams, and in skill development is associated with higher pay, lower quit rates and employee retention. Another examined how the adoption of innovative work practices that encourage worker participation and involve greater decentralization are tied to better organizational performance.

Manufacturers on a ‘high road’ tend to adhere to labour laws, pay more, resist exploitative practices, and develop specialized skills in workers. Workers in these systems appropriate more value than their counterparts in low-road systems, but they also contribute to greater value creation for the firm through their training and engagement.

In contrast, manufacturers on a low road are more likely to pay less, engage in exploitation, and resist engagement of workers in specialized training. The workers in low-road systems must compete to keep their jobs, and do not individually create as much value for the firm as workers with more firm-specific skills. It is through the employment of these less-skilled employees that the manufacturer competes to sell goods at low prices, and of relatively lower product quality, and with worse delivery-schedule adherence.

In theory, employers that engage in socially irresponsible practices operate systems that are not compatible with a high degree of worker human capital. That’s because workers feel greater dissatisfaction when subjected to these practices, and job dissatisfaction increases voluntary turnover. High worker turnover is more tolerable to these firms because their systems of manufacturing rely on unspecialized employee contributions, making replacement a simple task. These firms’ systems are ‘inelastic’ in the sense that they are less sensitive to worker contributions to value creation that come with training, skill development, commitment, and other mutual worker-specific investments.

In contrast, in employment settings of high specialization of human capital, employee turnover is more costly as new hires require significant training or experience to achieve the productivity of departed workers.

Also read: Do you care about your employees? Prove it!

Our Research

Classic indicators of manufacturing performance include product quality, on-time delivery, sales, costs, production speed and flexibility. In recent research, our data included two important outcomes in thousands of factories in the developing world:

Product quality. This can be profoundly shaped by the human capital of employees. In garment manufacturing, product quality in fabric cutting processes (present in 68.5 per cent of our manufacturer sample) comes from low defect rates when the fabric is cut by the operator. Cutting processes in turn depend on pattern-making practices, die designs, and cutting technologies that can vary by firm; more efficient patterns and dies can have a major impact on productivity and profit. To achieve full efficiency and low defect rates, workers in turn need skills in firm-specific cutting processes.

On-time delivery. This outcome depends on workers fulfilling daily production quotas to ensure that orders are completed in time for packing and shipping. Cutting, sewing, assembly, and inspection are the four most common processes in our study. Firm-specific processes inserted at any stage of the manufacturing process tie the successful attainment of production quotas to worker acquisition of human capital.

The links between irresponsible practices, worker turnover and the cost of cultivating human capital led us to the following hypothesis: The constraints that socially- irresponsible employment practices impose on the development of human capital generate poorer manufacturing outcomes.

Rooting socially irresponsible employment practices from supply chains

Throughout the 1990s, anti-sweatshop activist campaigns targeted multinationals that outsourced production to settings with abundant, low-cost labour and limited labour-law enforcement. Corporations targeted by these social movements often responded by making prosocial claims and adopting new practices to defend their reputations. One important response was the adoption of supplier responsibilityprograms seeking to enforce compliance with minimum labour and environmental standards. Today, more than 90 per cent of Fortune's top 250 global corporations have adopted supply chain codes of conduct, and more than half of all publicly-listed corporations in the food, textile and wood products industries have systems to manage supply chain responsibility.

Previous studies have found that supplier factories subject to this private regulation continue to exhibit wide variation in responsible employment practices. Even after repeated workplace audits, extended interactions with compliance personnel and training programs targeting noncompliant employers, irresponsible labour practices have been shown to persist in manufacturers of toys, food products, consumer electronics, footwear, and apparel. Our study focused on these export-oriented light manufacturing industries in emerging-market countries.

Our data was collected from an import-export firm that coordinates the purchase of goods from thousands of supplier factories on behalf of hundreds of clients, which are largely retailers and wholesalers based in North America and Europe.

Private labour audits help multinationals manage labour-related risk in their global supply chains and support the enforcement of labour standards. We analyzed factory audits conducted by the import-export firm to measure the presence of socially-irresponsible employment practices.

Auditors employed by the import-export agent visit each factory, review payroll documents and permits, interview workers, and inspect the production site. Crucially, social auditors assess only practices related to labour and environmental compliance; they are
not involved with measuring the manufacturing outcomes that serve as the outcomes in our research. This feature of the data provides assurance that the study does not suffer from a problem called “common method bias,” which occurs when differences across auditors generate a spurious association between irresponsible practices and manufacturing outcomes.

Auditors assess factory compliance against the import-export agent's “supplier code of conduct” that specifies proscribed employment practices, broadly aligned with international standards including core labour standards defined by the International Labour Organization (ILO).

The import-export agent's code of conduct includes over 50 measures of compliance. We selected eight that we believed are directly relevant to workers' rights and  well-being. These indicators are:
 

• failure to pay base wages according to local law;
• failure to pay overtime wages according to local law;
• failure to pay into legally mandated social insurance schemes;
• exceeding legal maximum working hours on a daily, weekly or monthly basis;
  
• failure to give employees at least one day of rest for each seven days of work;
• employing underage labour;
• failure to sign employment contracts with workers; and
• unethical disciplinary practices.

Our detection of these practices ranged from rare (in the case of underage labour and unethical disciplinary practices) to very common (excessive overtime hours and insufficient rest days).

Our Findings:

Socially irresponsible employment practices were strongly correlated within factories, and the presence of any individual practice was positively correlated with the presence of all others. Factories that failed to sign labour contracts with workers were also (i) less likely to have protections in place for the use of juvenile workers, (ii) more likely to use unethical disciplinary practices such as punitive wage deductions, (iii) more likely to pay less than the legally mandated wages and benefits, and (iv) more likely to require work in excess of overtime limits.

Consistent with our hypothesis, we found a robust association between socially irresponsible practices and inferior manufacturing outcomes. Whether measured by their presence or their prevalence, these practices were consistently associated with higher rates of quality defects.

The economic importance of the differences in manufacturing outcomes was greatest at the top of the performance distribution: Because of a dense concentration of producers in the upper part of the quality distribution, a 1.2-percentage-point decline in quality pass rate represented a fall from the 100th percentile to the 55th percentile.

A similar pattern appeared in on-time delivery performance: A 3.3-percentage-point fall in on-time delivery represented a fall from the 100th percentile to the 77th percentile. The effect was less dramatic at the median of the distributions, but still large enough to impact competitiveness.

Further evidence of the economic significance of these associations came from our findings on import-export agent purchasing. The presence of any irresponsible practice was associated with 18 per cent lower orders per employee. At the average order value per employee in our sample, this represents a decline from USD$10.5 thousand to USD$8.6 thousand per employee. At our median factory size of 250 employees, the reduction is roughly USD $475,000.   In a supplementary analysis, we estimated that any irresponsible practice was associated with an 18 per cent decline in purchasing.

Implications of Our Findings

The stakeholder perspective on socially irresponsible employment practices helps explain why violations of labour standards in global supply chains are persistent, and also why they resist many efforts to eliminate them. Consistent with past research on private labour regulation, our analysis shows that repeated monitoring through private compliance audits leads to only limited improvements in outcomes.  Over the first three audits, factories reduced harmful practices, on average; but in subsequent audits, they showed little improvement. Even after being audited six or more times, more than 55 per cent of factories exhibited at least one irresponsible employment practice.

Eliminating socially irresponsible employment practices is not simply a matter of imposing appropriate threats or blandishments on manufacturers. Getting onto a high road will require ‘institutional entrepreneurs’ who can drive change in their systems of complementary stakeholder relationships and practices that have historically driven many manufacturers onto the low road. This will require not only recognition of problematic practices, but the identification and promotion of a suite of alternative practices to replace them.

One possible approach to such institutional entrepreneurship would be for multinational enterprises to support transitions to high-road manufacturing by offering process-improvement programs to their suppliers that rely on investments in human capital. These intensive management interventions can improve a variety of operational metrics. The potential for the effectiveness of this approach is reflected in other research showing that process improvement interventions have spillover benefits for working conditions.

The theory also has implications for the growing literature on social movements and ‘private politics’ in management. Many activist campaigns have promoted corporate environmental stewardship by linking sustainability to economic efficiency, including cooperative efforts to reduce energy costs and waste. The theory suggests similar pathways may be available to social movement organizations seeking to advance social responsibility.

In closing

Our research suggests that firms can simultaneously pursue improved manufacturing outcomes and lower rates of irresponsible employment practices by promoting production systems that rely on developing the human capital of workers. This suggests an opportunity for economically-motivated programs that simultaneously improve labour standards in global supply chains.  

Our findings cast further doubt on the ability of multinational firms to compel suppliers in emerging markets to change their practices through monitoring alone. These manufacturers and their foreign buyers must work together to meet the challenge of eliminating socially irresponsible employment practices.

Greg Distelhorst is an Associate Professor at the University of Toronto’s Centre for Industrial Relations and Human Resources and the Rotman School of Management. Anita M. McGahan is University Professor, George E. Connell Chair in Organizations & Society, and Professor of Strategic Management at the Rotman School of Management. Their paper, “Socially-Irresponsible Practices in Emerging Market Manufacturers”, was recently published in Organization Science.

EDITOR’S NOTE: Professor McGahan and her co-author, Professor Keyvan Vakili of London Business School (Rotman PhD ‘xx), recently received the Academy of Management Journal’s Impact Award for “Health Care’s Grand Challenge: Stimulating Basic Science on Diseases that Primarily Afflict the Poor,” published in 2016.

[This article has been reprinted, with permission, from Rotman Management, the magazine of the University of Toronto's Rotman School of Management]