Warm-Glow Investing and the Greenwashing Hypothesis

There are many speculations, and some empirical indications in recent literature, that manufacturing firms are particularly prone to greenwashing, a practice by which such firms make misleading claims regarding their environmental performance or that of their products. Simultaneously, very recent evidence suggests that the representative investor has developed a preference for ESG (Environmental, Social, Governance) investments, a so-called "warm-glow" preference. The purpose of this paper is to provide a theoretical explanation why the preference for warm-glow investing may disappear if investors perceive firms in a sector to be greenwashing. We hypothesize that given the ubiquitous contemporary focus on greenwashing, rational investors will factor this greenwashing into their investment decisions. To test this, we investigate patterns of association of ESG scores, and both operating and stock performance for 3,245 listed firms, over a period of two decades, comparing the manufacturing and services sectors in the United States, Europe, and major Asian markets. We find that warm-glow investment is present within the services sector across all regions, but in the manufacturing sector we find noticeable regional differences. In particular, we find ESG-performance patterns for manufacturing firms in the United States that we consider consistent with perceptions of greenwashing. The contribution of this paper is to provide a nuanced perspective on how investors preferences change in relation to industry perceptions. The novelty in our study is two-fold: on the one hand, bringing the problem of greenwashing to the emergent literature on warm-glow investing; on the other, introducing warm-glow investing to the emergent literature on greenwashing.