Does the Market React to Greenwashing? The Impact of Alignment Between ESG Disclosure and ESG Performance on Capital Markets

Abstract

This paper examines whether stock returns and bid-ask spreads are influenced by Environmental, Social, and Governance (ESG) with two measures of ESG: (i) ESG related textual properties of 10-K filings for ESG disclosure; and (ii) Refinitiv scores for ESG performance. Using a U.S sample of 7,454 firm-year observations across all sectors from 2006 to 2021, our findings indicate that where the ESG content of 10-K filings are incongruent with Refinitiv ESG scores for greenwashers, there is a significant negative association with Cumulative Abnormal Returns (CARs). There is no market reaction where the 10-K filings are congruent with Refinitiv ESG scores. Bid Ask Spreads (BASs) are positively associated (i.e., higher uncertainty) with ESG content of modest green firms, but are negatively associated (i.e., lower uncertainty) with ESG content of non-green firms. Taken together, these results suggest stakeholders expect the ESG disclosures to be broadly positive but react significantly to corporate greenwashing as signs of weakness and doubt. Greater uncertainty is associated with modesty in ESG disclosures, but the view of non-green firms is shared more widely amongst investors. Overall, our results shed novel light on the market effects of ESG disclosure and performance with capital market reaction in terms of stock returns and uncertainty.