02 Nov 2006Working Paper Summaries

Resolving Information Asymmetries in Markets: The Role of Certified Management Programs

by Michael W. Toffel

Hundreds of thousands of firms rely on voluntary management programs to signal superior management practices to interested buyers, regulators, and local communities. Such programs typically address difficult-to-observe management attributes such as quality practices, environmental management, and human rights issues. The absence of performance standards and, in most cases, verification requirements has led critics to dismiss voluntary management programs as marketing gimmicks or "greenwash." Toffel examines whether a voluntary environmental management program with a robust verification mechanism attracts participants with superior environmental performance, and whether the program elicits improved environmental performance. His study focuses on the ISO 14001 Environmental Management System Standard, but the results have implications for voluntary management programs that govern many other difficult-to-observe management issues. Key concepts include:

A voluntary management program with robust verification, such as independent certification, can distinguish organizations based on their difficult-to-observe management practices. Third-party certification may be a critical element to ensure that voluntary management programs legitimately distinguish participants.
This finding is in sharp contrast with prior studies that found no evidence that superior performers disproportionately adopted voluntary management programs with weak or no verification mechanisms.
For firms, the evidence that ISO 14001 distinguishes adopters as less pollution-intensive many encourage firms to use ISO 14001 to screen suppliers.
Regulators should seriously consider using ISO 14001 as an indicator of superior performance.
The results of the study should encourage those who have designed or adopted other voluntary management programs that lack robust verification mechanisms to consider whether adding such a mechanism would substantially bolster the credibility of the program.

Author Abstract

Firms and regulators are increasingly relying on voluntary mechanisms to signal and infer quality of difficult-to-observe management practices. Prior evaluations of voluntary management programs have focused on those that lack verification mechanisms and have found little evidence that they legitimately distinguish adopters as having superior management practices or performance. In this paper, I conduct one of the first evaluations to determine whether a voluntary management program that features an independent verification mechanism is achieving its ultimate objectives. Using a sample of thousands of manufacturing facilities across the United States, I find evidence that the ISO 14001 Environmental Management System Standard has attracted companies with superior environmental performance. After developing quasi-control groups using propensity score matching, I also find that adopters subsequently improve their environmental performance. These results suggest that robust verification mechanisms such as independent certification may be necessary for voluntary management programs to mitigate information asymmetries surrounding management practices. Implications are discussed for the industry-associations, government agencies, and the non-governmental organizations that design these programs, the companies that are investing resources to adopt them, and those that are relying on them to infer the quality of management practices.