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 energy producers 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.

As of 2019, sustainable investing represents more than 20 percent of the $46 trillion in the U.S. assets under management. Compared to 2015, sustainable and impact investing has increased by more than 40%. A large contributor to this growth has been the 2015 guidance issued by the Department of Labor which allowed fiduciaries to incorporate environmental, social, and governance (ESG) factors into their investment decision. Given this push, flows to ESG increased substantially. Norges Bank, as an illustration, decides on the exclusion of companies from the fund’s investment universe, or to place companies on an observation list. In 2020, out of 167 excluded companies, 76 % of them were either involved in production of coal-based energy, caused severe environmental damage, or emitted unacceptable amounts of green-house gasses.

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