The new role for assurance services in global commerce.

• Author: Blair, Margaret M.

In this Article we examine the rapid emergence and expansion of a private-sector compliance and enforcement infrastructure that we believe increasingly may be providing a substitute for public and legal regulatory infrastructure in global commerce, especially in developing countries where rule of law is weak and court systems are absent or inadequate. This infrastructure is provided by a proliferation of performance codes and standards, and a rapidly growing global army of privately trained and authorized inspectors and certifiers that we call the "third party assurance industry." The growth in the third party assurance business has been phenomenal in the last decade. The business first developed to facilitate making and carrying out private contracts, but in recent years, assurance services are being deployed for purposes that are more appropriately seen as regulatory in nature. Third party assurance may thus be providing a new institutional structure through which private commercial exchange is being harnessed and regulated for essentially public purposes.

1. INTRODUCTION II. THE THIRD PARTY ASSURANCE INDUSTRY AND EVIDENCE OF ITS GROWTH A. The Impact of ISO B. An Overview of Assurance Organizations C. The "Professionalization" of the Inspection Industry III. FACTORS CAUSING A RAPID GROWTH IN DEMAND FOR THIRD PARTY ASSURANCE SERVICES A. Growth in International Trade and Outsourcing B. The Growing Complexity of Products and Increased Division of Labor Within Supply Chains C. The Need by Global Corporations to Assure That Contractors Can Meet Quality and Delivery Requirements D. The Need by Global Corporations to Assure That Contractors Can Meet Labor, Human Rights, and Environmental Standards 1. Recognition of the Risks to Global Brands From Problems in the Supply Chains 2. The Increasing Sophistication of Activists Pressuring Corporations About Environmental, Human Rights, or Labor Concerns 3. The Growing Demands for Transparency in Social Performance Indicators IV. AN EXAMINATION OF THESE DEVELOPMENTS: CHINA AS A CASE STUDY V. THEORETICAL AND POLICY IMPLICATIONS A. The Contractual Role of Third Party Assurance B. The Regulatory Role of Third Party Assurance VI. CONCLUSIONS I. INTRODUCTION

   The problem of organizing complex production has for the most part been analyzed by law and economics scholars in a dichotomous way: production can be accomplished either through a series of market transactions and contracts, or under the guidance and control of a hierarchical governance structure within a firm. (1) A rich and well-developed literature has emerged in the last few decades analyzing these two modes (as well as some "hybrid" modes), and considering why one mode might be used in some circumstances, and the other in different circumstances. (2) More recently, scholars have explored how globalization seems to be leading to more "outsourcing," in which activities that were once carried on within a single firm are now being organized by contracts, across multiple firms, perhaps in multiple countries. (3)

   Nearly all of the economic literature on choice of organizational form and the "outsourcing" phenomenon, however, assumes the existence of an institutional context in which rule of law is followed, minimum social standards and business norms are established and regulated (or are at least commonly accepted and followed within a given trade), and contracts can be enforced. (4) Given these characteristics of the institutional context, two firms that both operate in the United States or other developed countries, for example, can focus in their contracts with each other on the terms on which the subject of the contract will be carried out, without having to worry much about baseline or "default" terms. If firm A hires firm B to clean its offices and facilities, for example, A will not have to specify that B may not use child labor, may not dump its waste products in the municipal water system, and may not kidnap A's executives and hold them for ransom in order to get higher pay than the contract provides. Nor will the contract have to specify that either firm A or firm B can call the other into court to settle any future dispute over terms of the contract. (5) Those things are properly taken for granted, because both A and B will be subject to law, regulation, and customary norms operating in their respective countries.

   By contrast, firms that organize production through a long chain of suppliers in a global marketplace might have to be concerned about such problems, as well as numerous other problems that arise in the absence of a sophisticated and well-developed legal and regulatory infrastructure. At least three different literatures have touched on these problems: (1) scholarship in law and economics has considered the importance of rule of law and property rights protection generally to economic development; (6) (2) other work has focused on the problem of regulating environmental and social behavior of corporations in the global context; (7) and (3) the theory of the firm literature in law and economics has considered the standard problems of coordination, communication, and incentive structures in the "make or buy" decision.8 In the latter case, the literature has generally assumed that various parties contract with each other "in the shadow of the law." (9) There is also a relevant literature on the development, outside the law, of norms, reputational constraints, and arbitration mechanisms that may substitute for law in some circumstances. (10)

   In this Article we examine the rapid emergence and expansion of a private sector compliance and enforcement infrastructure that we believe may increasingly be providing a substitute for public legal and regulatory infrastructure in global commerce, especially in developing countries where rule of law is weak and court systems are absent or inadequate. This infrastructure is provided by a proliferation of performance codes and standards (some developed in collaborative processes by non-governmental organizations (NGOs) and business), and a rapidly growing global army of privately trained and authorized inspectors and certifiers that we call the "third party assurance industry."

   Third party assurance in some form or another has been used to facilitate commerce for centuries. (11) But its growth in very recent years has been phenomenal. (12) Moreover, whereas the third party assurance business first developed to facilitate the making and carrying out of private contracts, we claim that the activities of the assurance industry are rapidly being deployed for purposes that in the past would be considered "public" and "regulatory" in nature, and left to the authority of government. Third party assurance may thus be providing a substitute for both private and public law in a number of situations, and may even be providing a new institutional structure through which private commercial exchange may be regulated for essentially public purposes.

   We examine the new prominence of this industry in international commerce and the reasons why it has developed so dramatically in the last decade. We also consider whether the rapid deployment of third party assurance in business is facilitating the transmission of global "rule of law" norms of acceptable business behavior to new parts of the world, or whether, by providing a substitute for law, it is undermining the indigenous development of sophisticated legal systems.

2. THE THIRD PARTY ASSURANCE INDUSTRY AND EVIDENCE OF ITS GROWTH

   Perhaps the most familiar type of third party assurance service is the external auditor, who examines financial statements and the processes by which they were generated, and opines on whether the statements fairly and accurately reflect the underlying economic reality. (13) Independent external auditors have been critical to the development of liquid financial markets in which individuals may invest in market-traded securities issued by businesses with reasonable confidence that the information issuers have provided accurately reflects the condition of the underlying business.

   Financial institutions that invest in or insure business ventures have also long made use of other kinds of assurance services, in addition to financial audits. The business of assuring and attesting to non-financial matters began at least 180 years ago, for example, when marine insurance companies in France, Britain, and Italy began hiring inspectors to make sure that ships being hired for international commerce were sea-worthy. (14) Financial institutions, including insurance companies and lending institutions, generally continue to be among the most active users of a variety of third party assurance services. (15)

   1. The Impact of ISO

      A major contributor to the development of a global assurance service industry has been the widespread adoption since the mid-twentieth century of international standards and technical specifications for a vast array of products and processes under the auspices of the International Organization for Standardization (ISO). Since its founding in 1946, ISO has promulgated thousands of technical standards. (16) ISO also disseminates information about dozens of accreditation bodies that, in turn, accredit hundreds of organizations that are in the business of carrying out various evaluations to determine if products, processes, or management systems are in conformance with the specifications in ISO standards.

      In 1987, the ISO embarked on a significant new path when it adopted the "ISO 9000" standards of quality management. (17) These were the first sets of international standards that applied to management systems that firms have in place to meet customer and applicable regulatory requirements, rather than to the characteristics of the products firms produce or to units and methods of measuring those characteristics. (18) Although certification is not a requirement of the ISO quality management...