Probability & Partners: Uncovering greenwashing

3 december 2024

By Manos Ieronymakis, Quantitative Consultant at Probability & Partners

After introducing the importance of fast ESG scores in my last column, it is time to explore further how these real-time metrics can be used to identify and mitigate the risks of greenwashing – a practice where companies exaggerate or misrepresent their environmental efforts to appear more sustainable than they truly are.

Greenwashing is a growing concern in the corporate world, particularly as investors and consumers place increasing importance on sustainability. Traditional, slow-moving ESG scores can sometimes fail to capture the full extent of a company’s true environmental and social impact. This is where fast ESG scores come into play.

Our recent research has shown that discrepancies between slow and fast ESG scores can serve as early warning indicators of greenwashing. Fast ESG scores, which reflect public perception, often highlight issues that are not immediately apparent in company-reported data. For instance, if a company’s slow ESG score is high – indicating strong self-reported sustainability practices – but its fast ESG score is significantly lower, this could suggest that the public and media are sceptical of the company’s claims. Such a misalignment might point to potential greenwashing.

Jumping the gun

However, it is important to approach this analysis with caution. Fast ESG scores, while useful in identifying sentiment-driven discrepancies, do not provide definitive proof of greenwashing. They are an indicator – a signal that warrants further investigation. For example, a company may experience a temporary dip in its fast ESG score due to a negative news cycle, even if its overall sustainability practices are sound. Conversely, a company with a high fast ESG score might still be engaging in greenwashing if it has successfully managed its public image despite poor underlying practices.

One of the most valuable aspects of fast ESG scores in this context is their ability to detect changes in sentiment quickly. In our study of S&P 500 companies, we found that companies with significant misalignments between their slow and fast ESG scores were often those that had faced recent controversies or public scrutiny. By continuously monitoring these scores, investors can be alerted to potential greenwashing before it escalates into a more serious reputational or financial risk.

To illustrate, let’s consider a scenario where a company has been heavily promoting its new environmental initiatives, leading to a high slow ESG score. However, if media reports and social media posts begin to question the validity or impact of these initiatives, the company’s fast ESG score might start to decline. This decline could signal that the company’s sustainability claims are being scrutinized, and there may be more to the story than is presented in official reports.

Combining scores

It’s also worth noting that while fast ESG scores are effective in flagging potential greenwashing, they should not be used in isolation. Combining them with slow ESG scores and controversy indicators provides a more comprehensive view. Controversy indicators, which track negative events and public reactions, can add another layer of analysis, helping to confirm whether a dip in fast ESG scores is indeed due to genuine issues or merely a short-term fluctuation in sentiment.

In conclusion, our view on fast ESG scores is that they offer a powerful tool for detecting the early signs of greenwashing, but they should be used as part of a broader analysis that includes slow ESG scores and other relevant data. By understanding and leveraging the strengths of fast ESG scores, investors can better protect themselves from the risks associated with corporate misrepresentation. As ESG metrics continue to evolve, those who integrate these real-time insights into their decision-making processes will be better positioned to navigate the complex and ever-changing landscape of corporate sustainability.