Managing Legitimacy Risks in Dyadic Supply Chains: Supplier Environmental Controversies and Customer Green Innovation

ABSTRACT

Amid growing demands for sustainability and supply chain responsibility, supplier environmental controversies may trigger legitimacy spillovers to customer firms. However, existing research has paid limited attention to whether customer firms adopt substantive strategic responses to such controversies. Drawing on legitimacy theory, this study examines whether customer firms engage in green innovation as a strategic response to supplier environmental controversies and how external relationships shape this response. Using data on 1969 supplier–customer dyads among Chinese listed firms from 2010 to 2024, we find that supplier environmental controversies significantly stimulate customer firms' green innovation. This effect is amplified when customer firms exhibit higher network prominence or share common shareholders with suppliers but is weakened when customer firms have stronger political connections. This study extends legitimacy theory to supply chain sustainability by showing that green innovation serves as a substantive mechanism for legitimacy repair and that firms' strategic responses depend on external relational embeddedness.