Can investors curb greenwashing?

11 March 2024

This report analyses the phenomenon of greenwashing in companies due to investors’ pro-environmental preferences and their penalties for exposing past environmental controversies. The study presents the optimal communication, abatement policies, and greenwashing strategies of corporations, highlighting how investment decisions can clamp down on this practice. Policymakers can make use of these tools to reduce greenwashing and promote environment-friendly policies.

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OVERVIEW

This report studies the impact of pro-environmental preferences of investors and penalties for exposing past environmental controversies on corporate greenwashing practices. The study uses a dynamic equilibrium model with information asymmetry where optimal communication, emissions reduction, and greenwashing policies of corporations are characterised.

Equilibrium expected returns
The report highlights that the investors’ penalisation of revealed misrating commands a premium on the expected returns, scaling with the strength of the penalty. This means that the investor requires a higher return to hold the shares of companies whose environmental credibility is weaker.

Companies’ optimal greenwashing strategy
The report explains how corporations greenwash to inflate their environmental score above their fundamental environmental value, with a corresponding effort and impact increasing with investors’ pro-environmental preferences. The evidence suggests that limiting greenwashing practices is possible through investment decisions that penalise them.

Limiting greenwashing
Policymakers have several complementary tools available, such as policies increasing transparency, investment decisions that punish greenwashing, and environment-related technological innovation. Companies can benefit from information asymmetry about their fundamental environmental values; thus, policymakers should be transparent about environmental policies.

Empirical evidence
The report provides empirical support for the study’s findings, such as the frequency and dynamics of environmental communication being consistent with the model’s predictions. The study suggests a two-step empirical method analysing corporations’ environmental communication policies through monthly data from Covalence, a data provider to mitigate greenwashing partially through misleading communication.

Recommendations
The report provides insight into the optimal communication, abatement, and greenwashing strategies of corporations. Policymakers should implement policies that increase transparency, limit greenwashing behaviour and foster technology promoting abatement-related initiatives.