Investors who evaluate companies using environmental, social and governance (ESG) criteria are increasingly expected to use their influence to encourage more sustainable business practices. New research published in Strategic Management Journal finds that companies facing strong pressure from ESG investors tend to produce fewer direct emissions, but may sometimes shift pollution-intensive activities to suppliers instead.

The study found that while this outsourcing can lower emissions reported directly by a company, it does not necessarily reduce the combined emissions of the company and its suppliers. However, the researchers also found evidence that pollution outsourcing can be reduced when ESG investors help companies adopt greener technologies and extend their oversight to supplier practices.

ESG investing has grown substantially since the United Nations established the Principles for Responsible Investment (PRI) initiative in 2006. Assets under management by PRI-signatory investors increased from a few hundred billion dollars to more than $100 trillion by 2021, highlighting the considerable influence these investors may have on corporate environmental and social practices.

Researchers Shipeng Yan of the University of Hong Kong, Fan Zhang of Bentley University and Zhengyu Li of the University of Melbourne examined whether ESG investment genuinely improves companies’ overall environmental performance or moves pollution elsewhere in the supply chain. “Earlier research often used ESG ratings as the main outcome, which made sense at the time, but we now understand much better both what ratings capture and what they can miss,” Yan says.

The researchers focused on whether greater ownership by ESG-oriented investors influenced companies’ decisions to transfer pollution-intensive activities to suppliers. Using investor-level merger and acquisition events as quasi-experimental changes in firms’ ESG ownership, they analysed a global sample of companies between 2006 and 2019, drawing on greenhouse gas emissions data from Trucost.

Their analysis found that greater ESG investor ownership was associated with more pollution outsourcing to suppliers. Although companies could reduce their own direct emissions this way, the researchers found no corresponding decline in overall carbon emissions when emissions across the company and its suppliers were considered together.

One challenge is that investors often have much better information about the companies they own than about their suppliers. “Even experienced ESG investors may have good information about a focal firm but only fragmented information about its suppliers,” Yan says. Determining whether pollution is being shifted would require detailed supplier-level information about production, emissions and sourcing relationships, which may be incomplete, voluntary or commercially sensitive.

Despite these challenges, ESG investors may be particularly well positioned to help reduce pollution outsourcing. They can facilitate access to green technologies available through other companies in their portfolios, helping firms develop cleaner production capacity. At the same time, ownership stakes in suppliers may give them greater influence across supply chains. “The solution is not to expect investors to become procurement specialists, but to combine better value-chain disclosure and data with investor engagement, supplier oversight, and support for green technologies,” Yan says.

More information: Shipeng Yan et al, ESG investing and pollution outsourcing, Strategic Management Journal. DOI: 10.1002/smj.70115

Journal information: Strategic Management Journal Provided by Strategic Management Society