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Activism and Regulation in Global Commerce

Pursuant to the recent Kellogg / Aspen summit, my blog (first published on Huffington Post) reviews key insights from the event.

I recently wrote a post for the Public Relations Society of America (PRSA) blog which touched upon the focus of the upcoming Kellogg-Aspen Business and Society Leadership Summit, as it pertains to PR professionals.

Here’s a glimpse at the five things which we will be discussing in depth at the Summit, taking place at Kellogg School of Management on February 27-28, 2014 in Evanston, IL:

1. Private politics often outpaces government regulation.
2. Reputational risk transcends the boundary of companies.
3. Large companies are establishing standards unilaterally.
4. NGOs and activists are increasingly in the regulation business, but choose targets strategically.
5. Public expectations of corporate behavior have never been higher.

Before the end of the year, the 2013 edition of this year’s top ten reputational crises. No clear theme this year, but a wide variety of reputational challenges for companies big and small (and some governments as well).

[Bloomberg.com published a similar list for which I provided commentary to co-authors Suzanne Woolley and Ben Steverman].

1. The U.S. Government

The U.S. government is back on the list after its entry in our 2011 edition. In addition to the government shut-down and another debt ceiling scare, we had the revelations about the NSA (more on this in #2) and, finally, the disastrous launch of healthcare.gov. Things have started to lighten up a little towards the end of the year with the budget compromise, but ongoing worries persist.

The various problems faced by the U.S. government make a fascinating comparative case study with other democracies, especially those of the parliamentary type such as the UK, Sweden, and Germany. While the U.S. conflicts are largely a consequence of the bargaining and brinksmanship built into the American governmental system, parliamentary democracies face no such problems. In parliamentary democracies, the cabinet and the ruling coalition share the common interest to stay in power which leads to swift cooperation. However, there is a flip-side to the efficiency. Dramatic policy shifts can be passed with only slim majorities and without any need to search for broad support. Sometimes such policy changes are wise, often they are not.

For expansion upon this idea, read my October 4 interview with the Washington Post amidst the government shutdown article.

2. Big Data, Little Privacy

This year saw the first clear example of the dark side of big data. The wide-spread NSA surveillance program, leaked by Edward Snowden, continues to capture the world’s attention and has created a marathon crisis for the NSA and the U.S. Government.govt-listen[1]

A particularly interesting aspect of the crisis is the negative spill-over to companies such as Google, Yahoo!, and Apple. For a long time, privacy and data security concerns have topped the list of reputational challenges for high-tech companies. The NSA program not only creates tremendous attention for the issue, but also raises concerns over how much privacy policies can be trusted when the NSA knocks at the door (or finds a side-door to enter unbeknownst).

To escape this uncomfortable situation, leading tech CEOs formed an industry-wide coalition and urged President Obama to “move aggressively” to reform the way the U.S. government conducts surveillance. The approach may work, but, even if it doesn’t, it allows tech companies to distance themselves (at least partially) from the reputational spill-over of the NSA surveillance debacle.

3. The Rana Plaza factory, Bangladesh

It often takes a human tragedy to put an issue on the agenda. On April 24, the Rana Plaza factory complex collapsed in Dhaka, Bangladesh, killing 1,127 people, mostly women. The Rana Plaza factory was a supplier to many international retailers and brands including Walmart, Disney, The Gap, and H&M. Global media coverage quickly pointed to lax building construction and safety standards and poor working conditions. After considerable media outrage and activist pressure, companies either withdrew from Bangladesh or agreed to improved safety standards.07_Rana-Plaza-Collapse_Savar_2404131[1]

The case illustrates a broader, important phenomenon: the rise of private regulation of global commerce fueled by activists, (social) media, and public outrage. Many multi-national companies now require their suppliers to comply with global standards ranging from safety to labor conditions and minimum wage levels. Such requirements are not required by local law. Indeed, they usually dramatically exceed local practice. Supplier standards are usually mandated by private contracts, industry-wide agreements are sometimes legally binding, sometimes not. These rules and regulation have the same practical impact as traditional governmental regulation. A manufacturer that does not comply with Walmart’s environmental standards may effectively be shut out from the U.S. market. Industry-wide agreements have even more far reaching consequences. But governments play little to no role in creating and enforcing such agreements. They are negotiated and enforced by private parties: companies and NGOs.

For more details on this, see my article in the Chicago Tribune and NU Law faculty Caroline Kaeb’s blog post on the different legal environments for U.S. and European firms . The Kellogg School of Management, organized jointly with the Aspen Institute, will host a conference in February 2014 to further explore this topic of private governance.

4. Paula Deen

The collapse of Paula Deen’s Southern style comfort cooking empire could be just another example of the swift rise and fall of celebrities, but it also offers some broader lessons for businesses that are tightly connected with a particular person.

Credit: Supplied by WENN.com

Credit: Supplied by WENN.com

Other examples include Martha Stewart’s Omnimedia, Lance Armstrong’s Livestrong Foundation, as well as Tiger Woods’ corporate sponsors. In these cases, we have more than a simple association with a celebrity, as when a former quarterback endorses a car dealership. Rather, the connection goes far deeper, as the salient personal attributes of the celebrity are intended to rub off on the associated entity. Livestrong, for example, was built on the values associated with Armstrong: toughness, defiance, and a never-say-die attitude. The risk associated with highly personal brands is that the personal life of the endorser/founder/owner is closely tied to the success of the business entity (see my blog on this for more details). In case of a personal scandal, the positive spillover from an admired celebrity can quickly turn to a severe crisis, especially if the scandal undermines the very values on which the personal brand was built.

5. Barilla Pasta

IMG_0530

Posted at a restaurant in Chicago.

Yet another company found itself unnecessarily drawn into a controversial social issue. Like Chick-fil-a in 2012, the issue was again gay rights; the company was now the family-owned Italian pasta maker Barilla. During a September radio interview, Chairman Guido Barilla stated, “I would not do a commercial with a homosexual family, not for a lack of respect for homosexuals … but because I don’t agree with them and I think we want to talk to traditional families.

”Barilla went on to support gay marriage while condemning adoption by gay families.The story clearly illustrates the challenges of operating in a truly global media environment turbo-charged by social media. The story started in Italy, but its biggest impact was in the United States, where the issue of gay rights is on top of the political and social agenda. Gay rights activists quickly called for a boycott of Barilla products. Guido Barilla apologized, but the damage was done. To add insult to injury, rival pasta maker Bertolli created and distributed advertisements through social media, under the motto “Pasta and love for all!”For more on boycotts, see this blog entry.

6. Nasdaq – OMX Group

On August 22, the Nasdaq market shut down for three hours due to technological failures in a data feed. A different data feed failure occurred on October 29th . These problems followed on the heels of the problems associated with the Facebook IPO.Nasdaq

Quality concerns are among the most common sources of reputational crises. They go to the very core of what a company stands for and undermine trust in the company and its management. What made this crisis noteworthy was the fact that it hit an exchange. On the one hand, exchanges are somewhat isolated from immediate competitive threats due to the network externalities created by a large inter-connected customer base. On the other hand, the connectedness also can quickly lead to calls for regulatory action due to the systemic nature of the business, which brings us to banking and entry #7.

7. JPMorgan Chase

International banking topped the list last year. While most JPMorgan Chase’s problems go back to 2012 or earlier, this was a particularly tough year for the bank and its CEO, Jamie Dimon. Reputational damage, ongoing investigations, record legal fines JP-Morgan-Chase-300x225[1]and settlements constituted a never-ending string of bad news. Add to that hearings in the U.S. Senate, and this has been a tough year by any standards. Even Dimon’s Christmas card was savagely criticized.

8. SAC Capital Advisors

Exterior of Headquarters of SAC Capital Advisors, L.P. in StamfordWhen Steven A. Cohen’s SAC Capital Advisors pleaded guilty to criminal charges of insider trading, and agreeing to pay $1.2 billion in fines, it not only ended the money managing career of one of the most storied traders in the hedge fund world, but also cast a glaring light on an industry that usually prefers to operate out of the public’s eye. Following the conviction of Galleon founder Raj Rajaratnam for insider trading, it not only further heightened public scrutiny, but also created additional incentives for regulators and public attorneys to look even closer at suspicious business practices.

9. American International Group

This year’s gift that kept on giving was AIG. In a September interview with the Wall Street Journal, CEO Robert Benmosche compared the public outrage in March 2009 over $165 million in bonus payments to employees at AIG’s Financial Products Division, one of the epicenters of the 2008 financial crisis, to a lynching in the American south. Specifically, Benmosche stated that the criticism “was intended to stir public anger, to get everybody out there with their pitch forks and their hangman nooses, and all that — sort of like what we did in the Deep South [decades ago]. And I think it was just as bad and just as wrong.” For full article, click here.130709175442-aig-oversight-620xa[1]

Predictably the comment was met with outrage and calls for resignation. Within a few days, Benmosche issued an apology where he said “It was a poor choice of words. I never meant to offend anyone by it.” The question is: what was the point of bringing this story up in the first place?

10. Tesla Motors

And to conclude, something unusual: a successful rebuttal. On February 8, The New York Times article by John Broder severely criticized Tesla Motors’ Model S sedan’s battery life in cold weather as well as the effectiveness of its battery charging station. On the day after the publication of Broder’s article, Tesla’s CEO Elon Musk struck back. Using personal Tweets, TV appearances and an extensive blog, Musk attacked the article directly and asked the New York Times to conduct a full investigation. In particular, he pointed out that, unbeknownst to Broder, Tesla had begun installing monitoring software in its cars in 2008. The data, according to Musk, showed that Broder had actually set cruise control at a higher level than claimed, had turned up the car’s heater while on low battery and charged the car less and less with each stop. Musk also claimed that Broder had driven the car in circles with near depleted battery “for over half a mile, in a tiny 100-spot parking lot” instead of charging it. Following the post, Musk was defended by loyal Tesla owners using social media posts and letters to the Editor of the NY Times.

A day after Musk’s post, Broder posted his own rebuttal in The New York Times entitled “That Tesla Data: What It Says and What It Doesn’t.” New York Times Public Editor Margaret Sullivan subsequently entered the debate and stated that while Broder, in her view, “took on the test drive in good faith, and told the story as he experienced it,” he did not show good judgment in his fuel management. (For all of Margaret Sullivan’s comments, click here.)

When faced with negative media coverage, business leader dream of such a slam-dunk rebuttal, accompanied by passionate expressions of support by loyal customers, but such opportunities are rare. Companies rarely will have instantaneous exonerating data at their disposal based on meticulous preparation. Indeed, subsequent concerns over battery fires were not as easily put to rest.

models_coldweathertesting10[1]

This interview first appeared in the Washington Post’s Wonkblog on October 4, 2013.

[http://www.washingtonpost.com/blogs/wonkblog/wp/2013/10/04/how-a-game-theorist-would-solve-the-shutdown-showdown/]

Daniel Diermeier is the IBM Distinguished Professor of Regulation and Competitive Practices at Northwestern’s Kellogg School of Management; he also holds appointments in law and political science and directs Kellogg’s Ford Motors Center for Global Citizenship. A political scientist by training, he has written extensively on formal political theory, game theory and other topics relating to the modeling of political institutions. We talked on the phone Thursday afternoon; a lightly edited transcript follows.

By Dylan Matthews, Published: October 4 at 9:00 am

Professor Diermeier examines the forces at work creating the dysfunctional situation of the U.S. Government shutdown.  He goes on to compare the U.S. system with that of Europe – drawing some interesting conclusions about how these types of negotiations will take different paths given the fundamental differences in government formation.

This sign is in a window of a restaurant in Chicago, IL.

This sign is in a window of a restaurant in Chicago, IL.

This item first appeared on Bloomberg Businessweek’s “The Management Blog”, October 7, 2013.  [http://www.businessweek.com/articles/2013-10-07/barilla-in-hot-water-offers-a-lesson-in-reputation-management] In the classic Simpsons episode “Lisa vs. Malibu Stacy,” Marge Simpson tells her daughter: “Lisa, ordinarily I’d say you should stand up for what you believe in. But you’ve been doing that an awful lot lately!”Pasta purveyor Guido Barilla must know the feeling. After the Barilla Group chairman said in an interview that he supported a “classic family” and would never feature “a homosexual family” in his company’s advertising, he quickly found himself in hot water. Word spread via social media in a matter of hours, and now Barilla faces international calls for a boycott even after his hasty apology. Twenty percent of Barilla’s Wikipedia page currently covers the controversy, and competitor Bertoli quickly responded with pro-gay pasta ads and social media.

This is not the first time that a company has faced a reputational crisis over gay rights issues.  Target received boycott threats over its contribution to a political group that supported a candidate who opposed same-sex marriage. Fast food chain Chick-fil-A spurred a similar uproar in late July when President and COO Dan T. Cathy stated that Chick-fil-A supported “the biblical definition of the family unit.” While the deeply religious roots of Chick-fil-A’s founder and family owners were well known, the new comments quickly led to boycott threats by gay rights groups, statements by public officials in cities such as Boston or Chicago saying that the company was not welcome there, and the decision by the Jim Henson Company, creator of the Muppets, to no longer supply the company with toys.

In most cases, companies are well-advised to stay clear of polarizing issues. This can present challenges for multinational companies operating in multiple countries with diverse values. A comment that hardly raises eyebrows in a business’s home country may create outrage elsewhere.

Privately held companies such as Barilla may be particularly at risk if their governance structures are under-developed. Corporate boards can play a crucial role in insisting that management develops proper reputation management structures. And of course, if a CEO becomes the main problem, boards must be able to step in and replace a struggling CEO. This may pose a problem in family-owned business or publicly held companies that give founders or families effective control, such as News Corp during the 2011-12 hacking scandal.

That said, boycotts don’t always work. They require not only a controversial issue, but also sophisticated activist strategies. For example, boycotts are more effective if they target a single company rather than an industry to lower the costs of customer participation.

Sometimes a boycott over a polarizing issue can even pay off for a company.  After the attack on Chick-fil-A by pro gay rights groups, conservative advocacy groups and politicians quickly defended the company. Conservatives asked supporters to increase their visits, effectively organizing a “buy-cott.” The effort had some (limited) sales impact on Chick-fil-A, raising the intriguing and somewhat worrisome specter of consumer preferences that significantly correlate with political ideologies. But before embracing another new marketing fad, companies should be careful with (unintentionally?) defining themselves as a “Republican” or “Democratic” brand. Otherwise, they will be in for some interesting times.

For a perspective on the legal issues related to private regulation in the case of the Bangladesh factory collapse,  please find this guest post by Caroline Kaeb:

America’s Corporate Shield and Europe’s Enterprise Responsibility

Following the Rana Plaza Disaster

By Caroline Kaeb

The author is Visiting Assistant Professor at Northwestern University School of Law.

On April 24, 2013, the Rana Plaza factory building came crashing down in Dhaka, Bangladesh. More than 1000 garment workers, who stitched garments to supply the stocks of major international brands, were crushed to death. Aside from the usual condolences, how did European and American retailers react? The answer: very differently.

The Rana Plaza factory collapse was a human catastrophe that unleashed a long overdue discussion about the progenies of economic globalization and the responsibilities of multinational corporations. It is often underestimated how deep the differences really are on these fundamental questions between the United States and Europe, both of which are home to thousands of global companies. The regulatory industry responses to this Corporate Social Responsibility challenge on either side of the Atlantic vividly illustrate the division of attitudes.

In the aftermath of the Rana Plaza disaster, Europe’s “Accord on Fire and Building Safety in Bangladesh” (the European Accord) established a legally binding agreement among major retail brands to ensure that safety standards would be implemented in their supplier factories overseas. More than 70 companies, largely from Europe, have joined the agreement.

In contrast, the “Alliance of Bangladesh Worker Safety” (the North American Alliance), which brings together 18 North American apparel retailers and brands, constitutes a voluntary commitment in classical terms. Some have argued that the plaintiff-friendly litigious system in the United States is the reason for U.S. retailers to join forces collectively in a voluntary initiative. Allegedly, a non-binding structure would prevent resources being sunk into litigation costs rather than being used to advance the primary purpose of the initiative, namely, to improve safety conditions in factories. Others defended the North American approach by claiming that the responsibility of major retailers is solely to be drivers of economic growth (through employment opportunities) in emerging markets, not (primary legal and financial) guardians for safety conditions in supplier factories. While these considerations offer important perspectives, they fall short of addressing the more fundamental underlying premises and drivers for the different regulatory choices on each side of the Atlantic Ocean.

Granted, the European Accord and the North American Alliance share many common elements of responsibility for the manufacture of major retail brands, such as inspection of factories, training, information sharing, and advocacy with local governments. However, the different underlying premises of the European Accord and the North American Alliance become painfully obvious with regard to the ultimate remedy for non-compliance with standards by local factories. Whereas North American retailers would terminate their contracts with non-compliant factories, European firms assume a form of legal and financial responsibility by seeking ways to improve safety standards. The European attitude is to lean forward (apologies to MSNBC), whereas the American attitude leans backwards and hides behind a corporate shield to avoid any meaningful responsibility. The Bangladeshi factory safety situation is emblematic of a much deeper division between European and American corporate thinking about the role, function, and responsibility of corporations as key players in a globalized world.

Many commentators have been mainly concerned with the fact that competing standards in response to the Bangladeshi crisis have generated confusion for factory owners and international brands alike and have made factories move in and out of compliance.  Although a multitude of different safety standards can slow down progress in creating a uniform standard, they also signal in this case a more fundamental challenge.

The core question underpinning corporate regulation is how and to whom responsibility ought to be attributed in legal, financial, and moral terms. Traditional corporate theory and law provides for an impregnable corporate shield of protection that allows major global firms to outsource, by contract, production to supplier firms in low-cost emerging markets without bearing the risk of legal responsibility for the acts or omissions of its business partners. This model has facilitated the modern-day supply chain management model that minimizes risk.

So it has been a bold move on the part of more than 80 major retail brands under the European Accord to assume legal responsibility not merely for their own acts but also for their business relationships in the supply chain. This is going well beyond what is required under the current state of the law, where the corporate veil protects parent corporations even from liability for their (partially- or wholly-owned) subsidiaries, which span the globe as a complex and neatly constructed network. With regard to contractual supplier relationships, the legal barrier erected acts as a corporate “shield” that offers strong protections from liability beyond the traditional parent-subsidiary “veil” of protection. In North America, companies have mainly held firm to the classical school of thought that, however tragic the situation of Rana Plaza in Bangladesh, the legal and financial responsibility for ensuring safety standards lies solely with the direct owners of local supplier factories.

Thus, while the European Accord defies traditional ownership structures in favor of the recognition of an enterprise-wide concept of responsibility (casting a long corporate “shadow”), the North American Alliance confirms the status quo attitude of parent company liability for its own conduct and no more. North American firms are wise not to ignore this discernible gap between European and American expectations regarding Corporate Social Responsibility, since Europe remains a key market for American multinational corporations. Their European branches and subsidiaries are bound by the laws of the European Union (and its member states) even if the European affiliate entities operate outside of the territory of the EU. (The prominent extraterritorial tendencies of EU law are examined in a forthcoming article, which I have co-authored, in the American Journal of International Law.)

The different standard-setting approaches taken by European and North American companies are indicative of more than just an occasional and random difference in methodological approach. Rather, the dissonance in corporate thinking is of systemic nature and engrained in the DNA of the respective legal systems, societal norms, and history.

Unlike the United States, many European countries have a long tradition of stakeholder-sensitive corporate models and governance structures. The latest example is the United Kingdom, where the Commercial Act in 2006 UK was amended to extend director’s fiduciary duties to include stakeholder interests.  Further, the rise of “enterprise entity” theory in European circles has reinforced corporations’ responsibilities for their stakeholders. Under that doctrine, multinational corporations are seen for what they really are: economically integrated enterprises that comprise a complex world-wide network of subsidiaries, affiliate entities, and business relationships.  They are all stitched together by a European understanding of responsibility stretching far beyond the corporate shield so cherished in American law.

The European Court of Justice, as the highest court in Europe, has applied (at a jurisdictional level) an enterprise entity test in the context of EU antitrust law with the result that a non-European parent company can be held accountable for their anti-competitive behavior conducted through a European subsidiary. The European Accord shows that European corporate thinking has embraced the notion that a multinational corporation, as
a corporate group, is its own entity with distinct legal and moral responsibilities based on the reality of an economic unity between the parent company and its affiliate units. This indicates an increasing awareness that the traditional model of single unit limited liability companies may no longer be an accurate reflection of the new realities of complex corporate group structures, particularly when it comes to questions of Corporate Social Responsibility.

Considering that legal risks under the enterprise entity doctrine are still more the exception than the rule, there is a clear reputational risk for multinational retail brands that contract with supplier factories violating safety standards and endangering workers’ lives and health. European retail companies have understood the signs of our time where social expectations for global corporations have raised the bar beyond archaic legalistic compartmentalization of corporate groups with siloed or disjointed affiliate entities and without an overarching umbrella (such as an enterprise) responsibility for acts occurring within the group structure. European corporate thinking is following in the footsteps of the latest UN guidelines on business & human rights, according to which corporate responsibility exists not only for a company’s own business activities but also for its business relationships, primarily within its supply chain.

However, the United States has not been entirely immune to the imminent shift in social expectations and possible implications for legal responsibilities of global brands. Thus, in its decision in Baumann v. Daimler, the U.S. Court of Appeals (9th Circuit) has challenged the holy grail of “corporate separateness” by arguing that a subsidiary is an agent of the parent company if the subsidiary’s activities are “important to [the parent] [in a manner] that they would almost certainly be performed by other means if [the subsidiary] did not exist.” At least for subsidiaries in key markets, this requirement seems almost always to be met. Bauman v. Daimler has been accepted for review before the U.S. Supreme Court, which will be entrusted with the difficult task of deciding how impervious the corporate veil really is within the parent-subsidiary relationship. While under an American understanding legal responsibility normally extends, at most, to a company’s subsidiaries, the Europeans have extended legal responsibility well into a company’s contractual business relationships.  Corporate responses to the Bangladeshi disaster show that European sentiment seems to have transcended beyond the corporate shield of outsourcing practices by promoting legal responsibility for the failures and misconduct of contracted suppliers.

The regulatory actions to the Bangladeshi garment factory safety crisis have demonstrated that there is a broad gulf between Europe and the United States with regard to the expectations of global business acting as global citizens. This is not merely a disagreement about form in terms of legally binding versus voluntary commitments. Rather, it is a divergence on fundamental questions concerning the role of corporations in society generally and, more specifically, the responsibility of multinational corporations to perform with a social mandate in their network of global business relationships.

The European experience provides an important lesson for North American firms. In times of almost instant information flow through the internet, news outlets, and social media, it is more important than ever for companies to employ a comprehensive risk calculus. This should include financial as well as so-called “soft risks,” such as environmental and social factors, for their enterprise-wide operations. Soft risks can quickly translate into significant reputational damage that has the potential of causing serious harm to the company value for its shareholders. This is the very interest that ought to be protected by the limited liability structures created through the doctrine of “corporate separateness” and outsourcing practices. The public sentiment and government position in the United States about the responsibility of corporations also has started to change slowly but surely. The California Supply Chain Act is a prime example.

It is certainly fair game for companies to stick to a narrow compliance understanding until statutory law lays out legal obligations for them to take responsibility. This would mean, however, passing over the opportunity to distinguish themselves from competitors, build a strong consumer brand, and generate resilience capacities. Rare is the day that any company receives an award or praise for merely complying with the law, which is expected of every citizen of society as a baseline form of compliance. Companies should seize this opportunity to write their own stories as proactive members of not merely the global economy, but also of global society.

Private Regulation on the Rise

Public opinion, activism compel companies to demand changes in overseas plants; critics question legitimacy of deals

August 18, 2013

This Op – Ed originally appeared in the Chicago Tribune on August 18, 2013.  This is, in part, a response to an op-ed in the FT:  http://www.ft.com/intl/cms/s/0/3571cd26-ed75-11e2-8d7c-00144feabdc0.html#axzz2cRgaKl1O

By Daniel Diermeier

It often takes a human tragedy to put an issue on the agenda. The Rana Plaza factory collapse that killed more than 1,100 in Bangladesh was the deadliest disaster in the garment industry’s history.

European companies that outsource clothing manufacturing to Bangladeshi factories agreed to a new safety and working conditions code. U.S. companies stayed out, citing liability fears, and came up with an alternative plan.

This is not an isolated case. This year Apple and its main manufacturing contractor, Foxconn, agreed to improve labor conditions at Chinese factories. This decision followed months of controversy over alleged illegal overtime and poor worker housing, as well as a string of reported suicides. Wal-Mart also has embraced sustainable supply chains after it faced controversy over environmental issues.

These cases illustrate an important phenomenon: the rise of private regulation of world commerce.

This regulation is fueled by activists, social media and public outrage. Many multinational companies now require their suppliers comply with global standards ranging from safety to labor conditions to minimum wage levels. Such requirements are not required by local law. Indeed, they usually dramatically exceed local practice. These rules and regulations have the same practical impact as traditional governmental regulation. A manufacturer that does not comply with Wal-Mart’s environmental standards may be shut out from the U.S. market.

Governments play little to no role in such agreements. They are negotiated and enforced by private parties: companies and activist groups. This new form of regulation has sparked controversy. Recently, economists Jagdish Bhagwati and Amrita Narlikar have accused activists of bamboozling retail companies into taking responsibility for safety at garment factories, a burden that should rest on the factory owners. Exit doors existed, the scholars wrote, but managers closed them.

It is true that activists choose their targets for maximum impact, often focusing on famous consumer brands rather than the worst offender or the local manufacturer that has operating responsibility. My colleague Brayden King’s research finds that when a company is boycotted, the targeted company sees an average decline in its stock price of 0.7 percent for each day it receives national media coverage. A company’s decision to give in may mainly be the result of comparing the costs of compliance with the risk to its reputation if it keeps fighting.

Battles between companies and advocacy groups are “private politics,” contests fought between interested parties in the arena of public opinion. As with all forms of politics, they involve campaigns, deal-making, and the art of the possible. Some critics question the legitimacy of such arrangements. They may have the same consequences as public regulations but do not involve elections and due process.

Nevertheless, private politics increasingly plays an important role where traditional regulatory approaches are absent or ineffective. Plagued by corruption, or simply the lack of state capacity, governments may be unable or unwilling to regulate. Safety and labor standards in diamond mines will not be enforced unless there is pressure from their customers — multinational companies that care about their reputation.

Bhagwati and Narlikar raise the prospect of companies pulling out of Bangladesh, now that they are on the hook for safety. Workers would lose their jobs, and in fact, Disney announced in May it would stop using Bangladeshi suppliers. That is why it is better for private regulation to extend across an entire industry, and not just apply to one country. Standards should apply to all suppliers, not just those in Bangladesh, which would lessen the incentives for companies to exit.

As with any form of regulation, private regulation can burden companies, their suppliers and customers. Yet such costs can be more than offset by social benefits such as a cleaner environment or the protection of human rights. In a world of expanded media coverage, globalization and rising public scrutiny of companies, private regulation will only grow. Companies need to be ready for this challenge. Simply ignoring this phenomenon will not make it go away.

Daniel Diermeier is IBM professor of regulation and competitive practice and director of the Ford Motor Company Center for Global Citizenship at Northwestern University’s Kellogg School of Management.

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