False Stability? How Greenwashing Shapes Firm Risk in the Short and Long Run

This study examines the relationship between greenwashing and firm risk among listed Australian firms from 2014 to 2023. We construct a firm-level greenwashing score as the residual based on regressions of composite ESG on Scope 1–2 CO2 emissions; positive residuals indicate overstated sustainability relative to emissions. Using realized volatility as a measure of firm risk and applying the Generalized Method of Moments (GMM) regression framework, we uncover three key findings. First, contemporaneous greenwashing significantly lowers volatility, which is consistent with legitimacy and signalling theory, as overstated ESG credentials create a temporary perception of stability. Second, the risk-reducing effect is strongest with a one-period lag, likely reflecting delayed ESG and emissions reporting cycles and investor reaction times. Third, by the two-period lag, the effect reduces in magnitude, suggesting that markets eventually recognize the misalignment between ESG claims and environmental performance. Robustness checks with the E-pillar confirm these dynamics. Additional tests excluding the COVID-19 period (2020 and 2021) reveal that the risk-mitigating effects of greenwashing are even stronger during normal market conditions, implying that pandemic-related volatility may have muted the signalling power of ESG narratives. While firm fundamentals (e.g., book-to-market) explain part of risk variation, greenwashing-driven effects are economically meaningful yet short-lived. The findings underscore that greenwashing offers only temporary risk mitigation; as transparency improves and regulatory enforcement strengthens, firms relying on inflated ESG narratives face diminishing benefits and potential long-term risk penalties.