The level of greenwashing and cost of equity capital

Abstract

Under increased pressure to report positive environmental performance, some firms engage in greenwashing to create an impression of accountability and transparency while hiding their true performance. This study aims to assess whether greenwashing is costly by examining the impact of greenwashing on the cost of equity capital. Using a sample of 5,617 U.S. firms, I find that firms engaging in greenwashing exhibit higher equity financing. After controlling for multiple risk factors in my main regression model and performing additional tests, which aim to control for correlated omitted variables and endogeneity concerns, the results still hold. My findings contribute to the debate on whether greenwashing is priced by showing that the market can capture greenwashing since it increases a firm's cost of equity capital. First, to the best of my knowledge, this is the first thesis examining the association between cost of capital and the extent of greenwashing. This examination is critical as it sheds light on how the market values greenwashing and furthermore, there is yet little consensus on how to measure and identify greenwashing. Second, limited and imperfect information about firms' environmental performance contributes to greenwashing, and therefore affects the cost of capital. Finally, seeing that prior research highlights the importance of social performance for firm valuation and access to external investment, my study suggests that greenwashing is also important to firms as it has power to explain a firm's cost of equity beyond other risk factors.