Jan 24, 2025
I recently came across this very interesting research paper by two researchers from the ESSEC business school (Elise Gourier and Hélène Mathurin), called "the Greenwashing index".
This paper constructs an intriguing greenwashing index using natural language processing techniques on nearly one million Wall Street Journal articles from 1986 to 2022. Their two-step approach first identified climate risk-related articles and then pinpointed those mentioning greenwashing.
Here a few takeaways (which do not pretend to be exhaustive !)
1. Rising occurrences: Greenwashing has become significantly more prevalent in the past five years, with its mentions in climate-related news rising from less than 5% before 2018 to consistently above 8% since then.
2. Investor and financial sector relevance: The recent surge in greenwashing attention is primarily driven by skepticism towards the financial industry, particularly ESG funds, ESG ratings, and green bonds. Both retail and institutional investors react strongly to greenwashing news, reducing investments in green funds. Institutional investors decrease their investments in green funds by 8% the following month, while retail investors reduce theirs by 10% within two months.
3. Climate Risk pricing inefficiency: Greenwashing significantly impacts the estimation of stocks' sensitivity to climate risk, potentially distorting the climate risk premium. The distortion of climate risk premiums due to greenwashing suggests that markets may not be efficiently pricing climate risks. This inefficiency could lead to mispriced assets and potential market corrections as true climate risks become more apparent.
-> In that regard, see also my October 2024 article for AGEFI Luxembourg, highlighting this very same risk of asset mispricing and painful pricing corrections to be expected in the next years/decades.
Going into a bit more detail for Section , called "Impact of Greenwashing on Financial Markets", which explores how greenwashing affects investor behavior and the measurement of climate risk premiums.
6.1 Does Greenwashing Affect Investors’ Behaviors?
This section examines whether investor demand for funds reacts to unexpected greenwashing news. The study uses a dataset of 7,613 funds and analyzes fund flows in relation to greenwashing and climate shocks.
Key statements :
- Both investors with a preference for green assets and return-chasing investors may decrease their investment in green funds after reading greenwashing news.
- Time series regressions show a negative association between past greenwashing shocks and current flows, and a positive association between past climate shocks and current flows.
- Funds advertised as green are more affected by greenwashing news than other funds
- Retail and institutional investors react differently to greenwashing news:
- Institutional investors primarily drive the negative reaction of flows into self-labeled green funds, with a significant decrease in inflows following a greenwashing shock.
- Retail investors' reaction is not statistically significant in the aggregate
- Both types of investors increase their investments into self-labeled green funds following climate risk shocks, but retail investors react more strongly.
- Retail investors specifically target funds that are both advertised as green and have a five-globe Morningstar rating, while institutional investors focus on funds advertised as green, regardless of their Morningstar rating.
6.2 Does Greenwashing Impair the Measurement of Climate Risk Premiums?
This section investigates the impact of shocks to climate risk and greenwashing indices on stock returns.
Key statements :
- When abstracting from greenwashing, the conditional risk premium is positive most of the time.
- However, when accounting for greenwashing, the premium decreases and loses its statistical significance, indicating that greenwashing impairs the measurement of climate risk premiums.
6.3 Is Greenwashing a Risk Factor Itself?
This section examines whether greenwashing can be considered a risk factor24. The study augments the previous model by adding shocks to the greenwashing index.
The analysis acknowledges the possibility of greenwashing being a weak factor, due to its focus on the financial sector, and applies tests to account for this possibility.
Results show that when all individual stocks are included, the premium for greenwashing is much more sizable than the premium for climate risk.
After restricting the test assets to those with sufficient covariance with the greenwashing factor, the greenwashing premium remains sizable, while the climate risk premium is small and insignificant.
If time allows, I highly recommend reading this paper. Here is the link and below is the embedded PDF.
Romain Leroy-Castillo