A strategy designed to force dirty companies to clean up their act is having the opposite effect, creating a perverse financial incentive for polluters to stay dirty as long as possible.
New research from the University of Rochester reveals that socially responsible investors (SRIs) who buy into companies to “nudge” them toward sustainability are unintentionally causing environmental delays.
The study, conducted in collaboration with researchers from Johns Hopkins University and the Stockholm School of Economics, argues that the current logic of impact investing is fundamentally flawed.
Because impact investors are willing to pay a premium for the opportunity to turn a “dirty” company “green,” current owners realise they can make more money by selling the problem rather than fixing it.
“I might think, ‘Well, why would I invest in this project on my own? I can allocate my money somewhere else and wait until those socially responsible investors come along and give me their money because they care about making the world a greener place,'” explains Alexandr Kopytov, study co-author and assistant professor of finance at the Simon Business School.
Lucrative resale chain
This dynamic creates a lucrative “resale chain” for traditional financial investors who care only about profit. According to the study, these investors can purchase polluting firms at low prices and simply hold them, waiting to sell them to SRIs at higher prices later. This process effectively rewards waiting to enact environmental change rather than acting immediately.
“Well-intentioned investors just do not want to invest in a green firm that already has achieved everything it can,” says Kopytov. “Instead, they really want to make an impact with their money.”
To break this cycle, the researchers argue that investment funds must radically alter their mandates.
Instead of seeking out companies to fix, SRIs should publicly commit to paying premiums for firms that have already transitioned to greener practices. This would shift the financial incentive, encouraging managers to reform early to capture that premium themselves.
However, the authors warn that this approach requires binding, enforceable commitments. Without the threat of reputational or financial penalties, funds might be tempted to renege on paying extra for improvements that have already happened.
