Greenwashing as a Signaling game

Greenwashing is framed as a signalling game with firms sending news as signals. To identify greenwashing the top decile of firms announcing the most positive ESG news ex-ante is compared to the top decile of firms with the best ex-post ESG performance scores. Historically, equity returns did not reflect greenwashing gains but witnessed episodic gains. Contrary to popular perception, there is no incentive for brown firms to greenwash. The percentage of green firms that greenwashed has witnessed a decreasing trend from 90\% to about 70\% from 2005 to 2021. This high percentage, coupled with cheap news signals and lack of transparency in disclosures incline the game towards a worst social outcome of pooling equilibrium where greenwashing firms are indistinguishable ex-ante. The signalling model also explains the anecdotal evidence of 'greenhushing'. A mechanism design argues that policies encouraging greater disclosure and not penalties are more effective to curb greenwashing.