Investment in companies that engage in sustainable corporate practices is growing rapidly, with those companies receiving approximately $17 trillion from investors so far in the United States alone. As a result, the majority of public companies now voluntarily disclose environmental, social, and governance (ESG) information, touting plans to, for example, be “net zero” by a certain date. However, regulators generally allow companies to create socially responsible images without holding them accountable for the ESG goals they profess to have. This has led many stakeholders to accuse companies of “greenwashing:”  portraying a green image while not taking meaningful steps to achieve ESG goals and not disclosing ESG outcomes. In light of this, regulators have recently proposed to mandate the reporting of ESG information (e.g., ISSB, SEC, EFRAG).

In a recent study, we use a controlled experiment to examine how investors’ perceptions of greenwashing and investment decisions are influenced by a company’s disclosed ESG goals under both current and proposed regulations. We analyze whether the type of goal disclosed (i.e., a relatively high or low quantitative goal or a qualitative goal) influences investors’ perceptions of greenwashing and investment decisions after identical ESG performance outcomes are disclosed. Importantly, we examine how mandatory, compared with voluntary, disclosure of ESG outcomes change investors’ judgments and decisions. We design our experiment to test the effects of potential future regulations and identify potential unintended consequences of imposing such regulation.

Our theory suggests that, as investors evaluate ESG outcomes, they rely on previously disclosed ESG goals to form perceptions of greenwashing which, in turn, influence their investment judgments. Although prior research suggests that high quantitative goals are most effective at increasing output, our study shows that investors perceive more greenwashing and are less willing to invest in a company that discloses, but misses, a high quantitative goal, compared with achieving a low quantitative goal or a qualitative goal, even though the ESG outcome is identical in all instances. This finding is consistent with a recent report in which Nestle and P&G disclosed goals for “zero-deforestation” by 2020. Although both companies made great strides towards zero-deforestation (nearly 90 percent fewer forests cleared), an announcement that they would underperform their ambitious quantitative goal resulted in accusations of greenwashing and negative backlash from the media and various climate advocacy groups. Our results suggest that investors tend to infer managements’ intrinsic effort and intent by focusing on disclosed ESG goals rather than judging ESG outcomes in isolation. As such, corporate disclosures of specific,  goals that are most likely to maximize ESG results but are difficult to achieve could backfire if the company falls short.

We also predict and document a potentially important but unintended consequence of mandating ESG outcome disclosures. Psychology theory suggests that investors are likely to attribute different underlying motivations for disclosing ESG information, depending on whether the disclosures are voluntary or mandatory. Investors tend to attribute a voluntary disclosure to management but a mandatory disclosure to the external reporting environment. This suggests that disclosures of bad news are likely to be attributed to management acting in a forthcoming manner when made voluntarily but to the reporting requirement when mandated. In contrast, disclosures of good news are likely to be attributed to management acting in a self-serving manner when made voluntarily but attributed to the reporting requirement when mandated.

Consistent with theory, we find that an ESG reporting mandate magnifies the negative and positive effects of quantitative ESG goals on investors’ judgments and decisions. Specifically, mandating ESG outcome disclosures amplifies both the negative effects of underperforming a high quantitative ESG goal and the positive effects of outperforming a low quantitative ESG goal. Further, our findings show that this amplification is driven by investors’ perceptions of greenwashing. Thus, irrespective of whether companies engage in actual corporate greenwashing or not, our results suggest that investors’ perceptions of corporate greenwashing can have important implications for investment decisions.

Our findings provide important insights into how incentives that guide management’s ESG disclosure decisions could indirectly affect the extent of their ESG behavior. Considering that a key objective for companies, regulators, and society is to facilitate an overall increase in ESG activity, ambitious goals that prompt management to increase ESG output, though purposefully harder to obtain, would seem an effective way to achieve that objective. However, we find that perceptions of greenwashing alter how investors respond to ambitious goals if they are missed. Accordingly, our findings highlight a key tension for managers deciding whether and how to communicate ESG goals to investors while also being mindful of the overall benefits of increased ESG output. Managers may be better off disclosing more achievable, less ambitious goals. Importantly, this potentially counterproductive incentive to disclose low ESG goals appears to be exacerbated by mandatory reporting, in that missing (beating) a goal under a mandatory reporting environment further reduces (increases) investors’ desire to invest in a company. These findings highlight the need to develop disclosure regulations that both improve information quality and promote more ESG behavior. Further, regulators attempting to reduce actual greenwashing and improve the reliability of ESG information need to understand how ESG disclosure mandates may alter investors’ perceptions of greenwashing.

This post comes to us from professors Kirsten Fanning at DePaul University and Richard C. Hatfield and Chez Sealy at the University of Alabama. It is based on their recent paper, “Corporate CSR Disclosures and Regulatory Mandates: The Role of Investors’ Perceptions of Greenwashing,” available here.