The Paradox of ESG Investing: Greenwashing vs. Real Impact

Abstract

I propose a model to examine how investors with ESG preferences jointly influence firms' real green investments and greenwashing. Paradoxically, stronger investor ESG preferences may reduce real green investments due to increased greenwashing, which undermines the reliability of ESG information. When this information distortion is severe, firms are disincentivized to make real green investments, as the market-perceived ESG gains are obscured by misinformation, while the financial costs of green investments are still reflected in stock prices. This paradox is most likely to occur when the cost of manipulating ESG information is low, the correlation between ESG and financial fundamentals is weak, and financial information quality is high. Additionally, brown firms with poorer financial performance tend to greenwash more. These findings raise concerns that ESG investing could backfire without effective disclosure regulations. I analyze two practical measures to enhance real impact: diversifying green technology options and linking executive pay to ESG outcomes.

Keywords: ESG investing, greenwashing, real effects, information manipulation

JEL Classification: G11, G23, G32, M14