Sustainability or Greenwashing: Evidence from the Asset Market for Industrial Pollution

By | June 2, 2022

In response to increasing pressures from activists, regulators, and governments, firms are accelerating the divestment of polluting assets. While this trend reflects mounting concerns about climate change, a natural question is how effective these divestments are in reducing pollution. On the one hand, Environmental, Social, and Governance (ESG) supporters can point to successful pressures that have encouraged many firms to sell off polluting assets. On the other hand, selling off assets by itself does not necessarily reduce pollution, because someone else buys and operates them. This view raises concerns that the divestment of polluting assets is a greenwashing strategy through which firms convey a false impression that they are more environmentally sound.

In our recent paper, we aim to shed new light on this question by studying the reallocation of industrial pollution through acquisitions and sales of divested assets in the real asset market. Specifically, we examine what triggers the divestitures of pollutive assets, how toxic releases change around the transfer of ownership, and how sellers can benefit from those transactions. If driven by greenwashing, divestitures can bring substantial benefits to the seller while doing little to nothing to reduce overall environmental harm. Alternatively, if directed by market forces that efficiently allocate assets to owners most capable of treating pollution, divestitures should significantly reduce toxic release.

To evaluate these issues, we compile a novel dataset of 719 divestitures of pollutive assets from 2000 to 2020. We hand-collect and merge these data with information about plants’ toxic release and employment levels, ESG ratings, ESG-related incidents, Environmental Protection Agency (EPA) enforcement actions, U.S. federal government procurement contracts, and supply-chain and joint ventures. Using these data, we analyze the causes and consequences of pollutive asset divestitures. Broadly speaking, our findings reveal a strategic motive underlying these divestitures – greenwashing.

We begin our analyses by asking what types of assets firms divest and what triggers divestitures. We find that parent firms are more likely to divest an asset if it pollutes more. Moreover, parent firms are more likely to divest pollutive assets when facing pressures from activists, investors, and regulators. We measure ESG-related pressures based on public occurrences of negative events related to ESG risks, and particularly, environmental risks. These risk incidents typically involve criticisms and fines pertaining to climate change, greenhouse gas emissions, coal-fired power plants, gas flaring, carbon credits, etc. These findings suggest that pollution plays an important role in asset divestiture decisions and that divestitures may help alleviate environment-related public pressures.

Next, we ask whether sold assets generate less pollution under the new ownership. We find they do not. We track the changes in plant-level pollution, measured by the amount of toxic release and the intensity of toxic release per employee around the divestment of pollutive plants. We find no difference between the change in total toxic release at divested plants compared to plants that were not divested. In contrast, the intensity of toxic release per employee increases at divested plants by 11-14% following their divestment compared to plants that were not divested. These estimates indicate that, on average, buyers of pollutive plants reduce employment levels at the acquired plants while maintaining toxic release levels similar to pre-divestment levels. As such, we conclude that asset divestitures do not provide a social benefit of reducing pollution.

If not for social benefits, do firms sell assets to achieve self-interested benefits? We provide four results in this regard. First, after selling pollutive assets, firms see their overall ESG ratings increase considerably by roughly 22% relative to the sample standard deviation, and the improvement is particularly strong for environmental ratings. Second, sellers are 6% less likely to be hit by an EPA enforcement action following divestitures. Moreover, the costs of regulatory enforcement, including fines and cleanup costs, decline by over 70%. Third, following the divestment of pollutive assets, sellers receive on average $23.5 million more in government contracts due to eligibility criteria tied to pollution levels that the federal government imposes. Fourth, we find evidence suggesting that firms do not completely lose access to the sold plants. This is because pollutive assets are more likely to be sold to firms with business ties to the sellers, including pre-existing supply chain relationships or joint ventures with the sellers. Furthermore, the buyers also tend to develop additional business relationships with the sellers after they acquire the divested assets.

Importantly, we show that the above benefits, including the changes in ESG ratings, EPA enforcement actions, and government procurement contracts, can be tied directly to the divestment of pollutive assets. First, these effects only follow the divestment of pollutive assets and are nonexistent following the divestment of non-pollutive assets. Second, we do not detect a change in the levels of pollution of the remaining assets of the seller following divestitures, which indicates that the effects are not driven by changes in the unsold, remaining plants.

What can we infer from these findings? Firms enjoy various benefits from selling polluting assets, including higher ESG ratings, reduced environmental disciplinary actions and fines, and larger government contracts. Nevertheless, the assets remain pollutive, and transfer to other industrial firms that maintain customer-supplier or joint venture relations with the seller. As such, divestitures allow sellers to appear “clean” to investors and regulators without giving up their access to dirty assets.

Interpreted broadly, our findings suggest that regulators, rating agencies, and government procurement agencies reward the divestment of pollutive assets, even though these divestitures only reflect a cosmetic redrawing of the boundaries of the firm without any real effects on abatement efforts or overall pollution levels. Our evidence is more consistent with the view that the divestment of polluting assets is a greenwashing strategy through which firms convey a false impression that they are more environmentally sound to obtain the benefits associated with a stronger environmental image.

Ran Duchin is a Professor of Finance at the Carroll School of Management in Boston College.

Janet Gao is an Assistant Professor in Finance in the Kelley School of Business at Indiana University.

Qiping Xu is an Assistant Professor in Finance in the Gies College of Business at the University of Illinois Urbana-Champaign.

This post is adapted from their paper, “Sustainability or Greenwashing: Evidence from the Asset Market for Industrial Pollution,” available on SSRN.

The views expressed in this post are those of the author and do not represent the views of the Global Financial Markets Center or Duke Law.

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