By Lauren Cohen, L.E. Simmons Professor of Business Administration, Harvard Business School, Umit G. Gurun, Ashbel Smith Professor of Finance and Accounting, University of Texas at Dallas, Quoc Nguyen, Assistant Professor of Finance, DePaul University



No firm or sector of the global economy is untouched by innovation. In equilibrium, innovators will flock to (and innovation will occur where) the returns to innovative capital are the highest. In our paper, we document a strong empirical pattern in green patent production. Specifically, we find that oil, gas, and energy-producing firms – firms with lower environmental, social, and governance (ESG) scores, and who are often explicitly excluded from ESG funds’ investment universe – are key innovators in the United States’ green patent landscape. These firms produce more, and significantly higher quality, green innovation. Our findings raise important questions as to whether the current exclusions of many ESG-focused policies – along with the increasing incidence of explicit divestiture campaigns - are optimal, or whether reward-based incentives would lead to more efficient innovative outcomes.

Do ESG flows impact innovation?

As of 2019, sustainable investing represented more than 20% of the US$46 trillion in US assets under management. Compared to 2015, sustainable and impact investing has increased by more than 40%, driven by the Department of Labor guidance that allowed fiduciaries to incorporate ESG factors into their investment decisions. Norges Bank, for example, uses ESG factors to exclude companies from the fund’s investment universe, or to place them on an observation list. In 2020, out of 167 excluded companies, 76% of them were either involved in coal-based energy production, caused severe environmental damage, or emitted unacceptable amounts of greenhouse gases.

The most straightforward motivation for ESG investing comes from a preference for the goals that it aims to achieve. An investor with these preferences might be willing to sacrifice some risk-adjusted return for an ESG fund; or alternatively, pay more for a fund that promises the same ex-ante risk-return dynamics while delivering aligned ESG investment.

However, several other views could motivate ESG investing. For example, consumer preferences, product differentiation or talent acquisition might all be a source of comparative advantage that – if the market didn’t fully impound – could result in favourable future return dynamics.

The clearest counterargument is that ESG-focused fund managers are trying to maximise returns in a space dominated by unconstrained managers (those not adhering to ESG criteria), with ESG-focused fund performance decidedly mixed.

Moreover, there is limited systematic evidence that firms receiving disproportional amounts of capital from ESG funds have outperformed in any measurable way. Given this, our understanding of whether ESG investment flows impact the innovation that can help us solve environmental problems is incomplete.

Are traditional energy firms leading green patent production?

We investigate who produces green patents, the most influential of these producers, and whether investors who want to allocate capital toward ESG objectives actually end up investing in these producers.

As a starting point, as ESG capital investment flows have risen in the past decades, there has been a concurrent sharp increase in green innovation and patent production. We show that much of this is not driven by high ESG-rated firms, which are commonly favoured by ESG funds, but instead by traditional energy sector firms that are explicitly excluded from this investment universe. We use two datasets that capture all patents issued from 2008 through 2017 to identify the universe of green patenting activity. Moreover, much of our analysis of patenting entities concentrates on listed firms, due to there being rich, publicly available measures of firm characteristics, external activities, income, profitability, and patent holdings.

In addition, we show that a large and growing percentage of the energy sector’s patenting activity is dedicated to green research. The green patents of energy-producing firms are significantly higher quality, in terms of being more highly cited. Moreover, energy-producing firms are significantly more likely to produce blockbuster green patents[1] than other firms – including in the climate mitigation technology class.

Stepping back, we were still concerned that energy firms might be green patenting simply to block other firms from innovating in the space, or to shelve the patents and not invest real dollars in green energy projects. We collected data on the actual investment of energy sector firms to explore the depth and breadth of their complimentary production support of their green patents.

We found that energy-producing firms’ engagement in green patent production is not new. In fact, one of the most important and foundational patents in all solar technology development was filed by Exxon in 1978 (see Figure 1). A recent NPR article discusses how foundational Exxon’s patent and innovation was in the history of solar technology evolution (see Figure 2).

Moreover, we found other evidence that energy sector firms are being proactive in providing substantial investment to support alternative energy projects. Energy firms are significant global producers of alternative energy (electricity wattage) tied to their blockbuster patents and are central investors in some of the largest renewable projects worldwide (demonstrated by Shell’s involvement in NoordzeeWind, the first wind farm with capacity to generate over 100MW, built in the Dutch North Sea).

There is no evidence that energy companies are restricting others from innovating in specific product areas – with traditional energy firms’ patents being cited specifically by newcomers outside the traditional energy industry.

In total, we find consistent and robust markers that the quantity and quality of green patenting is higher for energy firms. Paradoxically, these firms are precisely those to which capital is often restricted by mandates and campaigns whose directive is to solve the important problems linked to green innovation.

Our analysis thus suggests there is a, perhaps surprisingly, negative relationship between the generators of innovation that can help us confront environmental challenges and where capital is being directed. Moreover, ESG scores, rather than helping push capital to its most efficient use with regard to this innovation, are in fact pushing money away from leading innovation.

Investigating these issues will provide critical insight into the shifting landscape of innovation, allowing us to capture and assess the full welfare impact of ESG capital on the economy.

Figure 1.


Figure 2. 



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