Exploiting Social Funds’ Desire for Impact through Imprecise Financial Climate-Risk Information

Abstract

Socially responsible funds that wish to make an impact subsidize firms to induce the adoption of cleaner products and technologies. We show that firms can exploit a social fund's desire for impact by measuring their financial climate risk exposure imprecisely. Relative to precise measurement, imprecise measurement of the firm's climate risk gives the social fund more room for impact, which increases the amount of subsidies the firm can extract. A by-product of imprecise measurement is that the firm and the social fund may invest in clean business strategies more frequently than what would be bilaterally efficient under precise measurement. Our model suggests that the current regulatory push for more precise financial climate-risk information can reduce the social fund's ability to make an impact and the firm's incentive to adopt clean business strategies.

Keywords: information design, climate-risk measurement, socially responsible investing, ESG reporting, impact investing

JEL Classification: D21, G32, M41, Q51, Q54