Greenwashing (misleading the public about the environmental responsibility of a corporation) is bad.
Because it is bad, news of Greenwashing negatively impacts stock market values. This latest finding by NUSC expert Dr Mao Xu and colleagues perhaps is not that surprising.
However, Dr Xu and colleagues found that not all firms are treated equally in terms of stock market responses. Companies based in Asia-pacific suffered significantly more than European counterparts. Manufacturing firms suffered more than service firms. Unsurprisingly, the more solid evidence of greenwashing- the greater the impact compared to mere suspicions. But most surprisingly, the better ESG performance historically (Environmental, Social and Governance) measures, the worse the market value degradation was. Why was this surprising? Let’s take a look at the explanations, and implications, for each of these findings.
To explore the impact of greenwashing on stock market valuations Dr Mao Xu worked with colleagues from Cardiff University, Professor Ying Kei Tse, Dr Ruoqi Geng and Professor Andrew Potter alongside Zhenyuan Liu from the China University of Mining and Technology
First, Dr Xu and colleagues sorted through news articles relating to greenwashing scandals between 2016 and 2021, narrowing down from 800 initial results to 121 cases of greenwashing by 68 publicly listed companies. They then utilised an event study method and stock market data to examine the impact that the greenwashing has on subsequent stock market price performance, utilising sophisticated statistical techniques to account for factors including the firms previous financial performance, growth potential and financial risk.
Why were the results about ESG performance surprising?
Most of previous research suggests that actually stronger previous ESG performance protects firms against the reputation damage of greenwashing and the subsequent negative market impacts. ESG, whilst costly to implement, pays off in long-term benefits in terms of market performance, reputation, stakeholder trust and competitive advantage. Further, because a firm has historically performed well in the sustainability space, perhaps the perception of the firm as intentional misleading is less present as consumers and investors are more forgiving: it must just be a mistake, or just this one instance, or they still have gone net good. Dr Xu and colleagues have some potential ideas for why they found the opposite effect:
- Firms with good ESG scores tend to be larger and better resourced – it can be expensive to be really good at ESG! But because of their size and resources, they are also under greater scrutiny and external pressures.
- Because of this greater scrutiny and exposure, when greenwashing is detected it calls into question the legitimacy of all previous claims.
- This severely damages the company’s image and reputation. This is exacerbated by the very fact that their reputational capital may be built on their sustainable image- that is, these companies are held to higher standards than their counterparts with lower ESG scores.
- Stock market prices fall.
Why do investors react more severely to greenwashing by Asian-Pacific companies compared to American and European companies?
Here, Dr Mao and colleagues draw on the idea of institutional distance to explain these observations. They argue that European and Northern American countries hold ideals and beliefs about ESG and corporate responsibility that are characterised by strict regulations and disclosure requirements. Whilst Asian-Pacific countries are increasingly concerned with sustainability and transparency, the perceived difference in approaches by European and American investors may lead them to judge greenwashing by Asian-Pacific firms more harshly, and more likely to indicative of broader wide-reaching breaches. This cannot be understood in isolation either – many Asian-pacific countries are undergoing rapid industrialisation with a high concentration of manufacturing firms, which we also know from this paper are more likely to be judged harshly compared to service firms. As manufacturing companies are such great contributors to industrial waste, any exposure of greenwashing results in magnified stock market responses.
What does this mean for companies?
The results from Dr Mao’s research is clear – regardless of location, industry and historic ESG performance, Greenwashing is going to lead to a negative reaction in stock market valuations. Knowing this can help corporate managers to really value the importance of true corporate sustainability behaviours and the need for accountability and transparency.
The bottom line: avoiding greenwashing should be the top priority for every company. Here, the idea of ‘too big too fail’ is actually reversed.
Want to know more? Read the full academic journal article here.
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