ESG Investing’s Blind Spot: The Supplier Tier

In 2006, the United Nations set up the Principles for Responsible Investment initiative in an effort to popularize the concept of integrating environmental, social, and governance factors into investment decisions. Between 2006 and 2021, the total assets under management by PRI-signatory investors grew from a few hundred billion dollars to more than 100 trillion. The growth illustrates the power that ESG investors could wield to impact social and environmental change — but a team of investigators wondered: When a firm appears greener, is the underlying environmental impact really improving, or could pollution be moving somewhere else?

The research team of Shipeng Yan of the University of Hong Kong, Fan Zhang of Bentley University, and Zhengyu Li of the University of Melbourne set out to determine if ESG investment really did improve firms’ underlying environmental impact, or if pollution was simply moving elsewhere. Their research, published in Strategic Management Journal, finds companies under strong ESG investor pressure do generate lower direct emissions; however, they sometimes shift pollution to suppliers, which doesn’t change their combined emissions.

“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. “That made us want to look beyond those metrics.”

For their study, the team used investor-level merger and acquisition events as quasi-experimental variations in firm ESG ownership in order to estimate the impact on pollution outsourcing, as such shifts help support the predicted causal relationship between ESG ownership and pollution outsourcing. They analyzed a global sample of firms from 2006 to 2019 and used greenhouse gas emission data from Trucost.

Their analysis showed that a firm’s ESG ownership is positively associated with pollution outsourcing to suppliers, and that this outsourcing does not result in a decrease in overall carbon emissions.

Yan explains that investors — even the most experienced — are set up to understand the companies they own, not to audit each tier of a global supply chain. And data on supplier-level production, emissions, and sourcing relationships are often incomplete, voluntary, or commercially sensitive. “That information gap is part of what makes this form of decoupling possible,” he says.

But the team also found that ESG investors do have ways of mitigating pollution outsourcing. For example, ESG investors may make pollution outsourcing less attractive by allowing firms to access green technologies from other portfolio firms. They might also hold more shares of a firm’s suppliers than others, which gives the investor even greater influence beyond the boundaries of the firm.

Yan points to Contemporary Amperex Technology Co., Limited (CATL), a global leader in battery technologies, as a recent example of investor stewardship. APG Asset Management and Robeco co-led the Principles for Responsible Investing (PRI) Spring 2024 engagement with CATL. Alongside this dialogue, CATL reports that its core battery-manufacturing bases achieved carbon neutrality in 2025 and it aims for value-chain carbon neutrality by 2035, including carbon-reduction and green-energy requirements for key suppliers.

“We would not say that these investors directly or single-handedly caused a particular technological decision,” Yan says, “but sustained investor engagement helped make the company’s low-carbon-tech adoption smoother.”

To mitigate pollution outsourcing, investors can’t be expected to become procurement specialists; however, better value-chain disclosure and data, along with investor engagement, supplier oversight, and support for green technologies, can make a big difference.