Overcoming bottlenecks in the transition to green technology

In the world of sustainable finance, green disclosure requirements — which mandate companies to report their environmental impact and sustainability efforts — play an important role in helping green investors make informed choices about where to put their capital.

Currently, there is a lack of research to guide regulators in designing effective green disclosure requirements, notes Deeksha Gupta, an assistant professor of finance at Johns Hopkins Carey Business School. How strict should the requirements be? Should they evolve over time? 

In a recent research paper, “Dynamic Green Disclosure Requirements,” written with Jan Starmans of the Stockholm School of Economics, Gupta provides insights on these and other important questions — insights that could have crucial implications for how to best incentivize firms to transition toward greener technology.

“One key takeaway from our modeling is that if regulators are very stringent initially that can actually backfire and disincentivize firms in their efforts to become greener,” Gupta notes.

Incentivizing through limited transparency

By modeling the green transition as a dynamic, multi-step process, Gupta and Starmans are able to study the implications of the costly initial transition to green technology for companies as firms undertake substantial capital expenditures for new green assets or engage in green research and development.

“We show that strict requirements early on may not be effective if ‘bottlenecks’ exist in the green transition process,” says Gupta, “and that regulators might benefit by implementing laxer disclosure requirements that effectively obscure firms’ precise level of greenness from investors.”

The researchers refer to this deliberate obfuscation as “government-mandated greenwashing,” which can create a “mis-valuation subsidy” that provides companies the investment incentives they need to overcome early bottlenecks.

As an example, Gupta cites a car manufacturer intent on switching production from gas-guzzlers to low-emission electric vehicles (EVs) — an attractive prospect for green investors. But where will the necessary lithium-ion batteries be sourced from, considering significant concerns surrounding the environmentally damaging methods used to extract cobalt, nickel, and lithium?

Through lax green disclosure requirements, such a firm would not be forced to disclose the sourcing of its EV batteries at the outset. This lack of transparency could be just enough for the company to get over the initial hurdle of shifting its manufacturing production to EVs, Gupta notes. “Then, in the future, as the firm gets its economic footing, disclosure requirements would get stricter, and the company would be in a better position to enact ‘clean’ sourcing of its EV batteries.” 

“Crucially,” write Gupta and Starmans, “the opportunity to obfuscate their greenness plays a pivotal role in motivating these firms to reform.”

More stringent over time

Critical to the example Gupta provides is the need to move from lax to stricter disclosure requirements as firms ramp up their sustainability capabilities. “We don’t want to remain in the ‘lull’ forever,” Gupta notes. “But it may be the case that many companies can’t make big, expensive, and far-reaching changes immediately. Our framework suggests that a dynamic approach could be optimal in incentivizing firms as they take initial, expensive steps to become more sustainable.” 

There is a trade-off between the speed and the breadth of the green transition, the researchers uncover: Dynamic green disclosure requirements may slow down the pace of green transition for some firms — while increasing the total number of firms that eventually reform. 

Gupta and Starmans say their analysis offers insights to regulators for assessing green policy initiatives. In their paper, they point out that many green disclosure requirements implemented in practice grow more stringent over time. 

In California, for example, companies are required to disclose “more qualitative information about their climate goals and claims in 2024,” they write, “and provide more detailed data on emissions starting in 2026.” Similarly, the U.S. Securities and Exchange Commission’s climate disclosure rules move from less detailed disclosures in FY 25 to more granulate disclosures related to financial expenditures and greenhouse emissions beginning in 2026.

Looking ahead, the design of these and other green disclosure requirements will be key to facilitating society’s green transition, Gupta believes, which underscores the importance of her analysis and findings.

“Given the climate crisis,” she says, “it is crucial to understand how best to incentivize firms to transition toward greener technology.”