Does ESG-linked Executive Compensation Improve Responsible Sourcing?

Abstract

With the rising importance of firms’ environmental, social, and governance (ESG) performance, an increasing number of firms have adopted ESG-linked compensation that ties managers’ compensation to the firms’ ESG performance. Responsible sourcing is an important dimension of firms’ ESG engagement. In this thesis, I investigate whether firms’ adoption of ESG-linked compensation improves their responsible sourcing. To construct my sample, I identify customer-supplier relationships between 2010 and 2020 from FactSet Revere, and firms’ use of ESG-linked compensation from ISS Incentive Lab. Using a staggered difference-in-difference design, I find limited evidence that customer firms’ adoption of ESG-linked compensation affects supplier firms’ ESG performance, regardless of the length of customer-supplier relationships. Cross-sectionally, I find some weak evidence that customer firms’ adoption of ESG compensation leads to improved ESG performance amongst their large suppliers, suppliers with greater market share, and customers in the manufacturing industries. However, customer firms do not exhibit a greater tendency to terminate their low-ESG performance suppliers. My study extends the ESG literature by examining the effect of ESG-linked compensation on responsible sourcing, a specific dimension that is part of firms’ overall ESG performance. My findings imply that stakeholders need to find alternative ways to promote responsible sourcing practices due to the limited effect of customer firms’ ESG-linked compensation on supplier firms’ ESG performance.