Integrating market structure and supervisory efficacy:A game-theoretic model of strategic greenwashing in ESG governanceOA

As environmental, social, and governance (ESG) factors increasingly influence capital flows and market competition, strategic greenwashing behavior by firms seeking to meet stakeholder expectations has become more prevalent. This intentional misrepresentation of environmental performance severely undermines market trust, distorts resource allocation, and impedes sustainable development, necessitating the establishment of effective governance mechanisms. We develop a multi-firm game-theoretic model in which companies privately observe their stochastic environmental performance and choose between truthful disclosure and greenwashing, while external auditors may detect and expose deceptive practices. Our study examines how greenwashing decisions are jointly determined by environmental performance uncertainty, market structure, and supervisory mechanisms, distinguishing between perfect and imperfect detection capabilities. Our findings reveal that under perfect supervisory detection, firms with worse environmental performance indicators are more likely to engage in greenwashing. Conversely, under imperfect detection, firms with fewer environmental issues are more inclined to exploit free-riding opportunities through greenwashing behavior. Additionally, market fragmentation systematically increases overall greenwashing risk when detection is imperfect. We identify a performance improvement paradox whereby insufficient supervisory capacity creates an inverted U-shaped relationship between aggregate greenwashing risk and firms’ actual performance. This relationship implies that marginal performance improvements can paradoxically increase overall greenwashing risk under certain conditions, leading to counterintuitive outcomes. Our analysis demonstrates that enhancing detection accuracy is a more effective governance approach than simply increasing penalties for greenwashing violations.