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What Is Green Finance And Why Should Companies Invest In Sustainable Finance?

Green finance is necessary to fight against climate change, but what is green finance? Why should companies care about sustainable finance?


Tue Apr 30 2024

Finance is at the heart of organizational climate transition. While it’s true that innovation and creativity are necessary to devise new ways of slowing down the climate crisis, without the vehicle of finance these ideas become just that—ideas.

For many companies now, it’s no longer a question of if they should be implementing sustainable financial instruments—it’s a question of when.

In fact, the United Nations Development Project (UNDP) outlines that financial instruments for climate mitigation need to increase at least three times to reach targets of limiting global warming to two degrees or below. 

This Earth Day, BusinessBecause spoke to Lorenzo Lesana, a PhD in Management student who is researching sustainable finance.

Why companies use green finance instruments

Lorenzo’s research as part of his PhD in Management at IESE Business School focuses on how companies use some sustainable financial instruments to increase their impact and green reputation.

“Companies use these instruments to signal internally and externally that the organizations care about environmental issues, but it’s still not clear how much audiences value this signal,” says Lorenzo, who has a career background in strategic consulting.

Since climate change is an enormous issue faced by almost every company and organization, the amount of funding that companies and countries require to fund environmental transition is impossible to reach with just one kind of investor.

“Companies can’t just rely on money from the government or private companies to invest in the huge amount of funding that’s needed,” he says.

Companies essentially use sustainable finance instruments to link their financial goals with environmental or social sustainability.

“Through issuing bonds to the market, companies can reach a much broader audience that can, and want to, provide funding for projects that help the environment.”

In this context, Lorenzo refers to ‘audiences’ as investors, such as shareholders or prospective shareholders.

Even for those less ecologically minded companies, there are long-term financial benefits for companies. For example, pension funds might be keen to invest in the environment because these reserves see the economic advantages of funding environmental transition.

“It’s about broadening the audience and reaching more capital that you can use for the environmental transition where huge capital is necessary,” he says.

Due to Lorenzo’s interest in sustainable investment, he spent a lot of time researching the right business school to study for his PhD in Management.

He says that IESE stood out to him due to its high standard of research among professors examining the intersection between strategy and the environment.

“Many of the papers I read before applying to the program were researched by IESE professors.”

The IESE PhD in Management is 100% funded and is open to both those coming straight from their bachelor’s degree or, similarly to Lorenzo, professionals who have a few years of work experience and want to pursue careers in academic research at top institutions. 

Barcelona, the home of IESE, is a city committed to renewable energy and waste management, with Biosphere clean-city accreditation. 

"Exploring green finance at IESE transformed my understanding of sustainable business practices. It equipped me with the tools to work on corporate strategies towards environmental sustainability. This PhD has been more than just academic growth—it's preparing me to lead change effectively in the global market," he says.

Examples of green finance

Green finance is a broad term that can encompass many different forms of financial instruments.

However, Lorenzo explains that there are two main use cases of sustainable finance instruments.

These are green bonds and loans, which are also sometimes referred to as ‘environmental’, ‘social’, or ‘sustainable’ bonds or loans.

Loans are usually provided by banks or lenders, but availability of funding might be limited.

These institutions may not possess the kind of money that those in the market, such as investors, have, explains Lorenzo.

Meanwhile, bonds are a relatively new domain and are provided by the market. When companies want to raise money to fund environmental projects, they issue green bonds. Investors can then purchase these bonds and lend money to the organization or company, with firms paying back the money over time.

“Bonds are useful because companies can use debt to fund environmental investments that enhance the companies’ green impact, such as solar panels on the roof of a building,” he says.

Why should companies care about their green reputation?

Lorenzo is researching the reasons why companies care about their green reputation.

“Using financial instruments helps companies signal to the market a commitment to environmental transition or social areas.

“It could help the company’s reputation at a time where many actors, such as shareholders, prospective shareholders, and other stakeholders, are looking at this aspect of the company’s reputation.”

Employees may also be influenced by this signal that the company makes to external parties, which can contribute to employee retention or talent recruitment.

One KPMG study found that younger workers are rejecting job offers based on companies’ ESG credentials.

“Companies are struggling to understand what the strongest signal to green commitment is without being perceived as greenwashing, which is challenging,” he says.

Avoiding greenwashing in business

Being accused of greenwashing in business can have a detrimental impact on a company’s reputation.

Lorenzo explains that the term greenwashing can be used at different levels: at a firm-level, selectively disclosing positive performance to hide their negligible overall performance (as said in a 2016 journal article by Marquis, Toffel, and Zhou), or at a product-level, over or under emphasizing the product's environmental impact to sell more (as said in a 2011 journal article by Delmas and Burbano).

To put it simply, companies participate in selective disclosure by, for example, publicizing an example of green commitment yet providing it with more weight than it has on the business’ overall strategy.

“The complexity lies in companies trying to find the balance between how to best signal green commitment while recognizing that this signaling places the company under the spotlight.

“The way for companies to avoid being accused of greenwashing is to have a real green strategy that’s integrated in every part of the company.

In the IESE PhD in Management, students learn about both quantitative and qualitive methods and take classes in their specialism. The program typically takes around 4 to 5 years of full-time study.

The global networking potential of the PhD is one of the factors that attracted Lorenzo to the program most. He says that the program has helped him to expand his knowledge and enabled him to meet other experts in the field.

PhD in Management students are even able to present their research at world-leading conferences.

Looking to the future, Lorenzo intends to research the areas of impact investment and social entrepreneurship. 

 “There has been a lot of generational changes over the years and social entrepreneurship has been growing.

“In the context of green loans and bonds, these financial tools are likely to remain in use as effective forms of green finance. Yet they will need more regulation,” he concludes.