DO CORPORATE ENVIRONMENTAL DISCLOSURES LEAD TO INNOVATION?

Author: Punit Arora

Firms are under increasing pressure to disclose their environmental performance, resulting in some exaggerating their results and others underreporting them.^1,2 At one end of the spectrum is “greenwashing”: firms exaggerate or fake eco-friendliness to influence stakeholder perceptions, conceal bad business practices, lower exposure risk, or alleviate competitive pressure.^3,4 Examples include Volkswagen’s falsification of vehicle emissions data, Coca-Cola advertising its PlantBottle, and Innisfree labeling a plastic bottle wrapped in paper a “paper bottle.”^5-7 These examples suggest that firms often use greenwashing as a substitute for real change and innovation.

“Brownwashing” is at the other end of the spectrum: firms hide or downplay their environmental achievements.⁸ These firms may be reluctant to state their true environmental performance, fearing backlash from anti-sustainability activists. For example, last year, several major banks and financial firms told Bloomberg they were burying ESG (environmental, social, and governance) in their reports and “quietly recalibrating how they talk about ESG investing in the US, navigating around potential political fights in order to avoid losing lucrative business.”⁹ Often, these firms do not just underrepresent their current performance, they lose interest in innovating further.

In between these extremes are “green-highlighting” firms that find the right balance between improving their environmental performance and communicating their actions. For example, firms that perceive significant reputational risks if they are accused of greenwashing have a strong incentive to meet their environmental commitments and maintain legitimacy.¹⁰

Using the context of heavy-polluting industries in an Asian country, this article examines the relationship between corporate environmental disclosure (CED) and environmental innovation (known as “ecovation”). It suggests that firms avoid greenwashing and brownwashing, as both are associated with lower innovation than green-highlighting strategies.

Why Disclose Environmental Performance?

CED has both direct benefits (e.g., reduced litigation costs, fines, and tax concessions) and indirect ones (e.g., green signals that help differentiate a firm in the crowded marketplace). Similarly, CED comes with explicit costs (expenses paid for writing reports and green marketing) and implicit ones (such as alienating some targeted consumers).

There are more subtle implications for firm performance. For example, consumers can usually differentiate between authentic and fake green performance, which can lead to changing consumer attitudes toward a firm’s products resulting in revenue decline.¹¹ This may lead to capital withdrawal by investors, reduced public trust, decreased brand value, and/or increased compliance costs from stepped-up regulatory scrutiny.^12,13

Consumers and markets will notice the dissonance between messaging and action at some point. Therefore, although small levels of greenwashing can create initial gains, once this behavior crosses a certain threshold such that symbolic disclosures exceed substantive ones, it leads to reduced consumer trust and a period of prolonged underperformance.

CED & Innovation

The relationship between environmental disclosure and environmental innovation (ecovation) is more complex. At one extreme are brownwashing firms, which choose not to disclose their true environmental efforts.¹⁴ As these firms are likely either content with their performance or hesitant to acknowledge it (fearing backlash from key constituents), they are unlikely to exhibit a significant appetite for further ecovation, despite their past positive performance.

At the other end of the spectrum are greenwashing firms. We know that greenwashing is often used to demonstrate false environmental commitments as a way to maintain social legitimacy,¹⁵ but we do not yet understand its impact on firm reputation, stakeholder perceptions, or long-term performance (research has found evidence of both negative and positive effects).¹⁶

Some research suggests that reputational concerns and risks cause greenwashing firms to eventually graduate from greenwashing to “real” greening.¹⁷ That is, some firms are pushed into innovation to ward off stakeholder pressure, loss of credibility, and reputational risks. For these firms, environmental disclosure that starts as a symbolic action may eventually create meaningful pressure that nudges the firm toward ecovation.¹⁸ My research suggests this is more likely to be the case for firms known as “green highlighters,” whose leaders know how to balance substantive and symbolic greening actions, as described below.¹⁹

Studying Heavy-Polluting Industries in an Emerging Economy

To better understand CED and ecovation, I obtained a sample of about 4,000 observations of large public firms in heavy-polluting industries in a large Asian country for the years 2013 to 2019 and analyzed it using advanced panel data regression methodology. This country’s current economic development and imperfect regulatory environment make it a perfect setting for examining behaviors that are often substituted for real change and ecovation, such as greenwashing.²⁰

Moreover, the country’s focus on green, sustainable development causes heavy-polluting industries to face more stringent environmental regulations, bringing development opportunities. To meet the requirements of environmental regulation while satisfying the market’s appetite for green products, both greenwashing and ecovation are emerging in these industries.

Underperformance Negatively Affects Ecovation

Thus far, research has not definitively shown whether firms with abundant resources are more likely to ecovate. Some studies suggest these firms are more willing to innovate,²¹ which implies that maintaining reasonable business performance is essential for ecovation. Other studies posit that because necessity is the mother of invention, firms may be more willing to innovate when confronting adversity.^22,23

Some research suggests that it’s not the performance itself that matters, it’s the gap between actual and aspired performance that shapes firms’ strategies and behavior, including environmental disclosures and innovation. However, research on how firms respond to the aspiration gap is still not clear. Some studies found firms that were not performing up to standards tended to avoid the level of expenditures needed for innovation; others found such firms were more likely to innovate their way out of their poorer performance.^24-26

In the case of ecovation, I found that the level and the duration of underperformance both affect behavior. Firms that have been underperforming on ecovation for years are more likely to indulge in greenwashing than to make actual improvements.

This is in line with researchers who found that underperformance not only restricts the ability of firms to obtain necessary resources, it leads to conservative business decisions. Faced with persistent, repeated underperformance and associated weakened investor confidence/capital investment availability, these firms choose conserving resources over investing in the future. Thus, a long underperformance period negatively affects innovation.

Firm Visibility & Innovation

Visibility refers to the extent to which a firm and its actions are known to its stakeholders.²⁷ High-visibility firms tend to be more responsible because of greater scrutiny by the media, nongovernmental organizations, and social movements. High visibility also reduces the level of information asymmetry between firms and stakeholders, promoting a fuller understanding of the company and its environmental disclosures.²⁸

Because high visibility makes it difficult for companies to cover up greenwashing (as well as brownwashing), it increases the costs associated with false environmental disclosures. For example, perceptions of hypocritical behaviors among consumers and other stakeholders can result in strong consumer backlash.²⁹ The increased explicit and implicit costs associated with greenwashing and brownwashing force firms to adopt real change and innovation.

Regulations Affect Innovation Levels

Although regulatory institutions do not directly affect the technical capabilities of the actors involved, governments tend to play an outsized role in shaping firm behavior.^30,31 This is especially true in countries with emerging economies: managing relationships with the government is vital to success because firms are dependent on governmental agencies for certificates/licenses, access to resources, and infrastructure services.

Thus, firms’ willingness to innovate is affected by their resource needs and sustainability goals and external pressure from regulatory institutions. For instance, if governmental supervision forces firms to internalize negative environmental consequences, they may be nudged toward making effective changes. Firms that were planning to satisfy stakeholders via greenwashing are confronted with an increased likelihood of being discovered and exposed. In contrast, weaker supervision may enable increased greenwashing.

So What Can Stakeholders Do?

This study of the complex relationship between CED and innovation showed that both greenwashing and brownwashing are associated with lower innovation than green-highlighting strategies.

My research suggests that some firms are unwilling to increase their ecovation investments because they perceive greenwashing will be easier and less expensive. Similarly, brownwashing firms are unwilling and/or unable to increase their environmental commitments, so their willingness to ecovate is inhibited. In contrast, firms that balance substantive action with symbolic disclosures are more likely to live up to their environmental commitments.

Underperformance duration, firm visibility, and regulatory effectiveness all influence the nature of this relationship:

• Underperformance duration is one of the main causes of low ecovation.
• Firms with high visibility are more likely to gain consumer recognition and consumer loyalty in response to their ecovation.
• The regulatory environment had a strong effect on ecovation. As a firm’s exposure risk increases, it can no longer rely on faking environmental performance. This leaves ecovation as the more feasible option.

These findings have important implications. First, although greenwashing can produce benefits in the short run, it has negative long-term ramifications for companies and society. In the long run, society will benefit from more sustainable economies, which can only be achieved through companies faithfully fulfilling their environmental commitments.

Second, although we did not specifically consider the fallout of false representations (greenwashing or brownwashing), at the very least, executives should consider reputational harm and associated loss of consumer confidence in the firm, including personal risks for owners and executives (e.g., Tesla’s recent difficulties).³²

Third, strong regulatory environments are useful for producing accurate environmental disclosures: firms may disclose more environment-related information to differentiate themselves and gain stakeholder support. However, tight regulation and increased supervision may be needed to ensure that such disclosures are verifiable and appropriate to discourage greenwashing practices.

Actions such as formulating standards for environmental information disclosure, requiring companies to provide appropriate evidence for disclosed information, and improving the supervision mechanism of environmental protection should be instituted to enrich the content of environmental information disclosure.

References

¹ Marquis, Christopher, and Michael W. Toffel. “The Globalization of Corporate Environmental Disclosure: Accountability or Greenwashing?” Harvard Business School Working Paper, 19 August 2011.

² Kim, Eun-Hee, and Thomas P. Lyon. “Greenwash vs. Brownwash: Exaggeration and Undue Modesty in Corporate Sustainability Disclosure.” Organization Science, Vol. 26, No. 3, December 2014.

³ Delmas, Magali A., and Vanessa Cuerel Burbano. “The Drivers of Greenwashing.” California Management Review, 2 December 2011.

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⁵ Hotten, Russell. “Volkswagen: The Scandal Explained.” BBC News, 10 December 2015.

⁶ Bain, Elizabeth. “Is Coca-Cola Greenwashing?” Train with Bain, 30 October 2021.

⁷ Prance-Miles, Louise. “Innisfree Accused of Greenwashing over Paper Bottle Claim.” Global Cosmetics News, 15 April 2021.

⁸ Neumann, Thomas. “Does It Pay for New Firms to Be Green? An Empirical Analysis of When and How Different Greening Strategies Affect the Performance of New Firms.” Journal of Cleaner Production, Vol. 317, October 2021.

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¹⁰ Berrone, Pascual, Andrea Fosfuri, and Liliana Gelabert. “Does Greenwashing Pay Off? Understanding the Relationship Between Environmental Actions and Environmental Legitimacy.” Journal of Business Ethics, 19 August 2015.

¹¹ Szabo, Szerena, and Jane Webster. “Perceived Greenwashing: The Effects of Green Marketing on Environmental and Product Perceptions.” Journal of Business Ethics, Vol. 171, February 2020.

¹² Wu, Xianhua, et al. “Effect of Air Pollution on the Stock Yield of Heavy Pollution Enterprises in China’s Key Control Cities.” Journal of Cleaner Production, Vol. 170, January 2018.

¹³ Zhang, Lu, et al. “The Influence of Greenwashing Perception on Green Purchasing Intentions: The Mediating Role of Green Word-of-Mouth and Moderating Role of Green Concern.” Journal of Cleaner Production, Vol. 187, June 2018.

¹⁴ Neumann (see 8).

¹⁵ Brammer, Stephen, and Stephen Pavelin. “Factors Influencing the Quality of Corporate Environmental Disclosure.” Business Strategy and the Environment, Vol. 17, No. 2, July 2006.

¹⁶ Du, Xingqiang. “How the Market Values Greenwashing? Evidence from China.” Journal of Business Ethics, Vol. 128, April 2014.

¹⁷ Berrone et al. (see 10).

¹⁸ Kölbel and Busch (see 4).

¹⁹ Neumann (see 8).

²⁰ Zhang et al. (see 13).

²¹ Garriga, Helen, Georg von Krogh, and Sebastian Spaeth. “How Constraints and Knowledge Impact Open Innovation.” Strategic Management Journal, Vol. 34, No. 9, January 2013.

²² Berrone, Pascual, et al. “Necessity as the Mother of ‘Green’ Inventions: Institutional Pressures and Environmental Innovations.” Strategic Management Journal, Vol. 34, No. 8, December 2012.

²³ Arora, Punit, and Prabal De. “Environmental Sustainability Practices and Exports: The Interplay of Strategy and Institutions in Latin America.” Journal of World Business, Vol. 55, No. 4, June 2020.

²⁴ Gaba, Vibha, and John Joseph. “Corporate Structure and Performance Feedback: Aspirations and Adaptation in M-Form Firms.” Organization Science, Vol. 24, No. 4, July 2012.

²⁵ Chen, Wei-Ru, and Kent D. Miller. “Situational and Institutional Determinants of Firms’ R&D Search Intensity.” Strategic Management Journal, Vol. 28, No. 4, April 2007.

²⁶ Shimizu, Katsuhiko. “Prospect Theory, Behavioral Theory, and the Threat-Rigidity Thesis: Combinative Effects on Organizational Decisions to Divest Formerly Acquired Units.” Academy of Management Journal, Vol. 50, No. 6, December 2007.

²⁷ Dattée, Brice, Oliver Alexy, and Erkko Autio. “Maneuvering in Poor Visibility: How Firms Play the Ecosystem Game When Uncertainty Is High.” Academy of Management Journal, Vol. 61, No. 2, April 2018.

²⁸ Prokofieva, Maria. “Twitter-Based Dissemination of Corporate Disclosure and the Intervening Effects of Firms’ Visibility: Evidence from Australian-Listed Companies.” Journal of Information Systems, Vol. 29, No. 2, August 2015.

²⁹ Durand, Rodolphe, Luc Paugam, and Hervé Stolowy. “Do Investors Actually Value Sustainability Indices? Replication, Development, and New Evidence on CSR Visibility.” Strategic Management Journal, Vol. 40, No. 9, April 2019.

³⁰ North, Douglass C. Institutions, Institutional Change and Economic Performance. Cambridge University Press, 1990.

³¹ Arora and De (see 23).

³² Higgins, Tim. “Elon Musk Lost Democrats on Tesla When He Needed Them Most.” The Wall Street Journal, 20 April 2024.