Sustainability in Academia (Article 1, May 2025)
Santhosh Jayaram
In India, we are at the peak of the reporting season because our financial year is from April to March. The sustainability teams are extremely busy with their sustainability disclosures and working overtime to ensure that their ESG ratings improve. There couldn’t have been a better time to explore the intricate connection between ESG ratings and Green washing. And to help me do it, the article I am reviewing is:
Kathan, Manuel C., et al. “What you see is not what you get: ESG scores and greenwashing risk.” Finance Research Letters 74 (2025): 106710.
The title is provocative, and that caught my interest. The authors are telling the investors that what you see is not necessarily what you get. The authors demonstrate through their research that investors focusing on high ESG-rated companies may be exposing themselves to higher risks of greenwashing.
We have all witnessed the unprecedented rise of ESG after 2018, followed by the equally unprecedented ESG backlash in 2023. The rise and fall of a topic have created an enormous interest in the academic community to study ESG. The findings of this article also support the viewpoint that ESG was not mature enough to be exposed to the limelight it received during a short period.
This article is interesting because the basic hypothesis is that the ESG scores are unsuitable for measuring environmental performance. While ESG scores have become a crucial criterion in investment circles, the absence of reliable ESG scores can hinder investment decisions. We have also seen cases since 2018 where investment firms have been subjected to investigations regarding greenwashing, and in some instances, these investigations have resulted in serious consequences. The researchers also highlight the lack of transparency in the methodologies used in ESG ratings.
The STOXX Europe 600 constituents is considered for the study as it covers 90% of the free-float market capitalisation in Europe. It makes sense to consider Europe, given the changes happening in the US, and Europe remains a favourable market for ESG. The researchers consider data from 2015 to 2023 and utilise ESG-related data from LSEG, Bloomberg, RepRisk, and S&P Trucost, as well as financial data from LSEG.
For greenwashing activities, they conducted searches for greenwashing and related terms across web search engines, NGO websites, and social media platforms. After collecting the information, a quality control check was performed, and 417 hand-collected instances of greenwashing were retained for the study. They also rated the severity of greenwashing on a scale of four levels, ranging from low to high.
The first level of analysis was conducted across countries and industry sectors to identify where the percentage of greenwashing cases was higher. In terms of the percentage of greenwashing observations against company years considered across countries, the top three were Germany, France, and the UK, in that order. However, these three countries contribute to almost 50% of the observations in the sample but represent only about 30% of the greenwashing cases. However, it is also interesting to note that countries like Norway and Finland, although having a lower percentage of greenwashing cases, have the highest mean severity of cases. When it comes to Industry sectors, the highest relative occurrences of greenwashing cases are in the Utilities (15.91%) and Energy (12.32%) sectors, and the mean severity, as expected, is highest in the basic material industry sector (which includes metals and mining).
The second level of analysis presents the number of greenwashing cases across double-sorted portfolios. On one axis, ESG scores are presented in four levels, ranging from Low to High, and on the other axis, company size is presented in four levels, ranging from Low to High. Then, in each cell across these axes, the number of greenwashing cases are plotted.
Across Bloomberg ESG Scores and LSEG ESG scores, the observation is similar in that the bigger companies with higher ESG scores have a higher number of greenwashing cases. Most greenwashing cases occur in high-ESG portfolios, with the frequency increasing as the company size grows. Thus, it is concluded that high ESG scores are positively correlated with an increased number of greenwashing cases, especially among large companies.
Now, in the third level of analysis, the researchers examine the mean ESG score from LSEG and Bloomberg for companies with greenwashing cases and those without any identified greenwashing cases. This is done for every year separately between 2015 to 2023. For both ESG ratings, the results are consistently high across all years, with the average ESG score for companies identified as having greenwashing cases being higher.
With these three levels of analysis, the researchers have shown a consistent trend that companies with higher ESG scores tend more towards greenwashing. The frequency increases when these companies are larger companies. The researchers reason that market pressures and reputation management are clear drivers behind this. Companies with higher ESG scores, which tend to be larger companies, attract more attention and come under higher scrutiny. These are also the same companies who then have a stronger incentive to maintain or improve their sustainability performance, which results in the exaggeration of their efforts.
The article continues to look at capturing the risk. To do this, they first attempt to identify the discrepancy between a company’s sustainable claims and its actual environmental impact, which can determine its risk of greenwashing. To do this, they need to estimate Apparent Environmental Performance (AP), which can be the perceived performance and the Real Environmental Performance (RP). The researchers now aim to identify variables related to a company’s greenwashing risk and subsequently employ a non-linear model using least squares regressions. Without getting deeper into the methodologies, let us look at the results and their interpretation thereof.
There is a plotting of AP and RP across the years between 2015 and 2023, which shows that while there is a significant increase in AP of around 40%, RP remains stable throughout the period. This would mean that while the actual environmental impact of the companies has remained relatively constant, the communication of their environmental strategies and forward-looking statements has increased. Later, in a correlation study between ESG scores and AP, RP, and greenwashing risk, it was found that ESG scores tend to be high when a company’s AP is perceived as strong. In contrast, ESG scores are higher for companies with low RP. Two key findings emerged at this stage. First, ESG scores partially reflect a company’s greenwashing risk, and this is critical because ESG information becomes increasingly embedded in investors’ decision-making and executive compensation inside the companies.
Second, the AP is strongly related to ESG performance. Thus, company-generated sustainability information through well-crafted reports can be unreliable and overestimate environmental performance, inflating ESG scores. This can be a powerful driver for companies to try to enhance their ESG scores by increasing AP, which in turn increases the risk of greenwashing. The results have been observed to be consistent with LSEG ESG data and Bloomberg ESG data.
In conclusion, this research suggests that the higher a company’s ESG score, the more likely it is to face greenwashing allegations, which in turn increases the risk for investors who use the ESG score as a measure of environmental performance.
For me, this study is significant, and companies must be aware that the difference they create between AP and RP increases their vulnerability and, consequently, the risk of greenwashing allegations. I have always maintained that a composite score covering Environmental (E), Social (S) and Governance (G) is of limited use. When presenting a composite score, there is an interaction between these three factors, as a strong social performance might offset a moderate environmental performance and vice versa. So, Investors using ESG scores were always at risk because of the composite nature of ESG scores, but now this research proves it. It is also a call for ESG ratings to reevaluate their approach and adjust accordingly to mitigate this risk. Overall, it is a great article with insights that can be useful for companies, ESG rating agencies, and investors using ESG scores. Be aware – What you see is not what you get.
Academics on Sustainability
The mainstream sustainability professional appears to be a world away from the research being conducted in the academic space. This is a series of articles I will be posting as a review of some very interesting journal articles that the academic world has put out. It will focus on the key findings and my views on their implications and takeaways. I will focus less on academic rigour and more on the key messages that will be of interest to sustainability professionals and key management personnel. I plan to do this monthly.
Cutting through academic jargon, this monthly series distills key findings from sustainability research into actionable insights for professionals and decision-makers.
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