Restoring Trust in Sustainable Finance: The Role of Active Supervision in Greenwashing Scandals

Greenwashing scandals pose significant financial risks to banks and asset managers. However, companies implicated in greenwashing do not experience immediate share price declines until supervisory authorities take formal action. Our recent study reveals that mere public allegations and media discussions of greenwashing fail to provoke a reaction from investors. When supervisory authorities launch investigations, however, the company’s market value drops by an average of 6 percent, compared to the expected development without supervisory intervention. If the authorities proceed with a raid, the company’s value decreases by an additional 5 percent. This effect is not due to the greater severity of cases that are investigated. Even for the same greenwashing allegations, we do not observe any investor reaction when the allegations are made or complaints are filed—only when the supervisory authorities take action.

Why do share prices drop? Investors take new information into account when evaluating the company’s future prospects. [1] If they anticipate that the exposure of greenwashing practices will harm the company financially, some investors will sell their shares, leading to a decrease in the company’s value. This situation puts pressure on the company’s management to end its greenwashing behaviour. Our study shows that, in cases of greenwashing, this correction does not occur in response to the publication of new information; it only occurs when supervisory authorities become active.

Greenwashing undermines the good intentions of individuals who want to invest their savings in companies that genuinely contribute to the socio-ecological transition, rather than in those that harm the climate and environment. For example, some investment companies market their investment products as sustainable, even though their so-called “green” mutual fund portfolios may include a significant proportion of oil and gas companies. So far, the EU’s rules for sustainable financial markets have done little to curb the prevalence of these empty green promises. [2]

Given the omnipresence of greenwashing, it might seem that this problem has no solution. After all, when civil society and the media expose greenwashing cases, the result just a brief media frenzy that fades away before the next case emerges, and the whole cycle repeats itself. Although negative publicity can affect a company’s public image, we sought to determine what needs to happen in the wake of greenwashing claims to compel companies to make concrete changes out of a fear of financial repercussions. The answer: active supervision is key.

Based on the results of this study, Finanzwende is urging Germany’s Federal Financial Supervisory Authority (BaFin) to take stronger action against greenwashing in the financial markets. BaFin must ensure that all financial actors adhere to the relevant regulations – both in their spirit and wording - and systematically pursue all cases of wrongdoing. These demands apply not only to rules for financial products like green funds, but also to the promises made by financial services institutions, such as in the context of voluntary climate commitments. The widespread use of greenwashing in the financial markets will not be curbed until market actors can realistically expect consequences for their false green promises.

The greenwashing scandal at DWS, the asset management subsidiary of Deutsche Bank, perfectly illustrates the findings of our study. In this case, the investment company significantly overstated the share of its assets that were invested using ESG criteria. When a whistle-blower publicly revealed these allegations in 2021, there was no noticeable reaction in the capital market. In other words, shareholders did not expect the accusations to have any financial consequences for the company, despite the fact that they came from a prominent insider.

However, the announcement of investigations by the U.S. Securities and Exchange Commission (SEC) and the German Federal Financial Supervisory Authority (BaFin) resulted in a massive 17 per cent drop in DWS share price – relative to the price fluctuations for DWS that would have been expected for this period in absence of this announcement. The sudden drop in share price is shown in Figure 1. When DWS offices were subsequently raided by police investigating the greenwashing claims, the company’s share price plunged an additional 12.6 per cent, as can be seen in Figure 2. The timing of these dramatic declines in share price supports the findings that investors do not react to greenwashing allegations until the financial supervisory authorities take action.

The study shows that investors only react to greenwashing events in specific situations: namely, when financial supervisory authorities launch investigations or carry out raids. In these cases, the stock prices of the companies involved decline, putting pressure on the company’s management to cease their greenwashing practices.

Figure 3 presents the estimated effects of five different categories of greenwashing events [3] on the share price of the companies involved. [4] The stock market reactions to greenwashing lawsuits, reported greenwashing incidents, greenwashing complaints filed with supervisory authorities and activism in response to greenwashing in the days immediately preceding and following the event are not statistically significant. Only the negative effect of supervisory measures is statistically significant. In these cases, the stock price of the companies involved fell by an average of 1.8 per cent.

An evaluation of the subcategories (Figure 4) shows that, among the various supervisory measures, only investigations and raids had a significant and strongly negative effect. In these contexts, the value of the companies fell by an average of 6.5 per cent and 5.3 per cent, respectively.

Normally, stock markets react immediately to new information about companies, quickly adjusting their expectations, which is reflected in the stock prices. However, in cases of greenwashing, investors tend to react not to the information itself but rather to the actions taken by supervisory authorities. This can be attributed to the rarity of penalties for greenwashing offenders in the financial sector thus far. As a result, capital market participants have often not anticipated that greenwashing allegations would have any financial consequences for the respective company.

In contrast, when cases of accounting fraud are exposed, the capital markets typically react to the very first reports, rather than waiting for the supervisory authority to intervene. This suggests that, in the case of accounting fraud, investors are confident that the supervisory authority will respond appropriately. [5] Such certainty is still lacking when it comes to greenwashing allegations.

Our data sample includes 90 greenwashing events that occurred between 2021 and 2024. These events have been classified into five categories (see Table 1). Multiple events can be associated with a single case of greenwashing; for instance, various incidents such as whistle-blower reports, the initiation of investigations, or the filing of a lawsuit can all stem from the same underlying claim. Stock market price data for the companies examined in this study was obtained from Refinitiv Eikon.

Table 1: Categories and subcategories of the greenwashing events examined in the context of this study

We used an event study methodology to examine the impact of greenwashing events on the share prices of banks and asset managers. To assess investor reactions, we focused on the “abnormal returns” of a company, which are the returns that deviate from what would be expected based on the company’s situation and prevailing market conditions. [6] Consistent with current event study literature, we employed a three-day event window, spanning from one day before to  one day after the event. We also ensured that no other events influencing the company occurred within this event window.

Why does studying investor reactions help us identify the factors that motivate greenwashing companies to change their behaviours? Share price is a crucial metric for evaluating a company’s success, and management closely monitors it.[7] When the share price drops, the company’s management is under pressure to address the situation, in this case, by ending greenwashing practices. If management believes that greenwashing allegations could negatively impact the company’s share price, there is greater pressure to avoid false promises and to communicate sustainability claims in a transparent and straightforward manner.

• In most cases, capital markets do not react to greenwashing accusations until financial supervisory authorities take action, launch an investigation and, if applicable, impose penalties. These findings clearly demonstrate that active financial supervision is one of the most effective tools for combating greenwashing.
• Nevertheless, it is both appropriate and important to expose cases of greenwashing through research studies, investigative journalism and whistle-blower reports, even if the immediate impact is not always visible. Publicizing this information can have long-term effects by shaping a company’s public image of a company and often serves as the basis and/or impetus for the supervisory authority to take action.
• If supervisory authorities regularly investigate greenwashing allegations, companies will take the potential consequences seriously and, ideally, ensure that all information they share about their sustainability is honest and transparent from the outset.
• We are calling on Germany's Federal Financial Supervisory Authority (BaFin) to take stronger action against greenwashing, to systematically pursue all cases of wrongdoing and to ensure that all financial services institutions in Germany abide by the rules.

Currently, the rules on green investments are undergoing changes. In the future, clearer requirements that help investors recognise and understand sustainable financial products can also contribute to reduce greenwashing.

[1] E. F. Fama, ‘Efficient Capital Markets’, Journal of Finance 25, no. 2 (1970): 383–417, https://doi.org/10.2307/2325486.

[2] ESMA, 01.06.2023, Press Release: ESAs put forward common understanding of greenwashing and warn on risks, last accessed on 1 August 2024. https://www.esma.europa.eu/press-news/esma-news/esas-put-forward-common-understanding-greenwashing-and-warn-risks.

[3] More information on the methodology and categorisation below.

[4] The dot represents the cumulative “abnormal returns”, averaged over all events of the same category. The line represents the 95 per cent confidence interval, indicating the range within which 95 per cent of all estimates from this category lie.

[5] S. R. Ahmad et al., Investor Reaction to the Discovery of Accounting Fraud: The Period from the Discovery of the Fraud to the Completion of the Correction, Academic Journal of Interdisciplinary Studies 10, no. 6 (2021): 171–90, doi.org/10.36941/ajis-2021-0163;

S. Numata and F. Takeda, Stock Market Reactions to Audit Failure in Japan: The Case of Kanebo and ChuoAoyama, The International Journal of Accounting 45, no. 2 (2010): 175–99, https://doi.org/10.1016/j.intacc.2010.04.004;

Y. Wang, J. K. Ashton, and A. Jaafar, Money Shouts! How Effective Are Punishments for Accounting Fraud?, The British Accounting Review 51, no. 5 (2019): 100824, https://www.sciencedirect.com/science/article/abs/pii/S0890838919300307.

[6] In this context, we apply the Fama-French three-factor model, which allows us to control for the company-specific influence of the market situation, the expected deviations associated with the difference between the returns of small and big companies and the expected deviations associated with companies with a higher book-to-market ratio. See: E. F. Fama and K. R. French, Multifactor Explanations of Asset Pricing Anomalies, The Journal of Finance 51, no. 1 (1996): 55–84, https://doi.org/10.1111/j.1540-6261.1996.tb05202.x.

[7] M. O’Connell and A. M. Ward, Shareholder Theory/Shareholder Value, Encyclopedia of Sustainable Management (Springer, 2023), 2918–24, doi.org/10.1007/978-3-031-25984-5_49.