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Market May Reward 'Greenwashing' Over Green Results

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By KC McKanna

A growing number of people are interested in investing in companies that perform well environmentally as well as economically. Unfortunately, measuring environmental performance is not as straightforward as calculating a simple financial return on investment. Developing a yardstick for environmental performance is inherently fraught, forcing evaluators to reduce all of the complex dimensions of sustainability, greenhouse gas emissions, water consumption, biodiversity impacts and other factors into a single value. Unsurprisingly, there is no consensus on the "right" approach and a proliferation of methodologies has caused confusion and eroded confidence among potential investors. When researchers at UCLA and McGill University conducted an evaluation that disentangled the different dimensions of environmental performance, they found troubling results. The study revealed that the market appears to be measuring and rewarding sustainability efforts that don't necessarily translate into meaningful outcomes.

The research team examined the performance of over 200 US firms using three of the leading methodologies of KLD Analytics, Trucost, and Sustainable Asset Management (SAM). These rating systems are particularly influential, KLD and Trucost are used to compile Newsweek's Green Rankings and SAM data is incorporated into the Dow Jones Sustainability Indexes. They also rely on very different sets of information. While KLD rankings are calculated using mostly publicly available data obtained, SAM takes the opposite approach, using mostly company survey responses. Trucost compiles data from a range of sources including government census and surveys, industry statistics, and national economic records.

After using the three methodologies to evaluate the performance of the 200 sample companies, the researchers analyzed the relationship of metrics along different dimensions of sustainability. Most importantly, they divided the different metrics into two key groups, those that measured processes and those that measured outcomes. Process metrics measure internal corporate sustainability efforts like sustainability reporting, governance, or the use of environmental performance systems while outcome metrics measure actual environmental impacts like natural resource consumption or pollution.

The study revealed that process metrics were not as linked to outcomes as had been expected. There are several potential scenarios that could be contributing to this phenomenon. It is possible that internal sustainability processes simply aren't working, or are less effective at reducing environmental impacts than they were designed to be. It is also possible that companies with large ecological footprints are more likely to undertake sustainability efforts. A more cynical interpretation could be that companies are "greenwashing," adopting ineffective sustainability processes while continuing to engage in environmentally damaging practices.

While outcomes are the only thing that ultimately matter, processes may be easier to measure and report. The tendency of rating systems to rely on process metrics has the result of making process performance more visible and skewing ratings to potential the detriment of firms that are achieving real environmental results. The same study found that companies that excelled along the process dimension also enjoy greater financial success relative to companies that did better along the outcome dimension. The market is rewarding firms for undertaking visible, but ultimately ineffectual, sustainability efforts, while those firms that are making a measurable positive impact on the environment are not being rewarded as well.

If the socially responsible investing community hopes to retain the confidence of investors that care about meaningful progress toward sustainability and overcome concerns about greenwashing, it must improve transparency and start measuring the things that really matter.

See: "Triangulating Environmental Performance: What Do Corporate Social Responsibility Ratings Really Capture?" by Magali A. Delmas, Dror Etzion, and Nicholas Nairn-Birch in Academy of Management Perspectives, August 2013

Photo of Magali Delmas courtesy of the Institute of the Environment and Sustainability, University of California, Los Angeles.

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