Does green innovation affect firm misvaluation? Evidence from environmentally sensitive firms

Green innovation has become increasingly important to firms operating in environmentally sensitive industries. It can reduce resource use and environmental costs, improve regulatory preparedness, create new market opportunities, and strengthen corporate reputation (Huang et al., 2023; Rahman et al., 2020; Rehman, 2025). These benefits suggest that green innovation should contribute positively to firm value. Yet its economic value is difficult to determine. Green innovation often requires substantial upfront investment, while its commercial benefits emerge gradually and remain dependent on technological feasibility, regulatory change, and market acceptance (Aastvedt et al., 2021; Bauweraerts et al., 2022). Its intangible and technically complex nature further complicates the estimation of future cash flows and risks (Fiorillo et al., 2022; Yin and Xin, 2024). Therefore, green innovation presents an important valuation problem. Investors may recognize it as favorable information without accurately determining how much value it creates.

Green innovation generates an upward valuation response because it conveys information about firm quality and future prospects. Developing environmental technologies, products, and processes requires financial resources, technical expertise, and sustained managerial commitment. Such investments can signal technological capability, environmental commitment, and preparedness for regulatory and competitive change (Chen et al., 2023a; Guo et al., 2023; Tsang et al., 2023). Investors have a rational basis for responding positively to these signals because the underlying capabilities may improve efficiency, reduce environmental exposure, and support future growth. However, identifying a favorable signal is easier than assigning it an appropriate economic value. When reliable benchmarks are limited, investors may rely on simplified interpretations, sustainability narratives, or prevailing market sentiment (Khan et al., 2024; Lin et al., 2023). The association of green innovation with technological leadership, regulatory advantage, and sustainable growth may lead investors to place greater weight on its prospective benefits than on its implementation costs, commercial risks, and delayed returns. Market value may consequently increase more than estimated intrinsic value.

The implications of this upward response depend on the firm's initial valuation position. For an undervalued firm, market value is already below estimated intrinsic value, possibly because investors have overlooked the value of intangible assets and long-term investments. Green innovation can reveal previously underappreciated technological capabilities, growth opportunities, and preparedness for environmental transition. The resulting increase in market value narrows the gap with intrinsic value and represents a partial correction of undervaluation (Benlemlih et al., 2021; Bofinger et al., 2022). The same response has a different implication for a firm that is already overvalued. Its market value may be supported by optimistic growth expectations, favorable narratives, or heightened investor attention. Green innovation provides an additional positive signal that confirms these expectations. Because its prospective benefits are more salient than its uncertain costs and risks, investors may respond more strongly than the underlying economic change warrants (Khan et al., 2024; Yang et al., 2024). Market value then moves further above intrinsic value, amplifying the existing overvaluation. A positive valuation response to green innovation therefore does not uniformly indicate either improved pricing accuracy or greater mispricing.

The strength of this response may also depend on the visibility of green innovation. Consumer-facing firms communicate with end consumers through recognizable products, brands, advertising, and public sustainability initiatives. Their environmental activities are more observable to consumers, the media, retail investors, and ESG-oriented investors (Haddock-Fraser and Tourelle, 2010; Rahman et al., 2020; Chen et al., 2023a). Greater visibility makes information about green innovation easier to recognize and may strengthen perceptions of firm quality, environmental responsibility, and future growth. It also increase investor attention and reinforce sentiment-driven reactions. By contrast, green innovation in industrial-facing firms is often embedded in production technologies, pollution-control systems, intermediate inputs, or supply-chain processes. Although these initiatives may create substantial economic value, their technical nature makes them less observable to consumers and non-specialist investors (Tang et al., 2018; Liu et al., 2024a). The valuation response should be stronger when firms have greater direct consumer exposure.

Despite growing research on the economic consequences of environmental innovation, three questions remain unresolved. First, most studies examine whether green innovation improves financial performance, environmental performance, or firm value (Aastvedt et al., 2021; Hao et al., 2022; Liu et al., 2024a). These studies provide evidence about value creation but do not establish whether equity markets incorporate that value accurately. A rise in market value may reflect a rational response to improved fundamentals, a correction of prior undervaluation, or excessive investor optimism. Second, studies of sustainability-related mispricing generally rely on aggregate ESG performance or disclosure measures (Bofinger et al., 2022; Wang et al., 2024; Yang et al., 2024). Such measures combine diverse environmental, social, and governance dimensions and may conceal the particular valuation difficulty associated with green innovation. Green innovation combines favorable long-term potential with high technological uncertainty, intangible investment, and delayed commercial returns. Third, limited evidence explains why the same information produces different valuation consequences across firms. In particular, the roles of initial valuation status and direct consumer exposure remain insufficiently examined. We address these gaps by investigating how green innovation affects the market-to-intrinsic value ratio, whether the effect differs between initially undervalued and overvalued firms, and whether it is stronger among firms with greater consumer exposure.

We examine these questions using an unbalanced panel of 2,075 firm-year observations for 152 environmentally sensitive firms across 35 countries from 2002 to 2021. Green innovation is measured using the Thomson Reuters Eikon Environmental Innovation Category Score. Relative valuation is captured by the ratio of market value to estimated intrinsic value. Firm fixed-effects estimates show that green innovation is positively associated with this ratio. However, the economic meaning of this increase differs across valuation states. Among undervalued firms, it moves market value closer to estimated intrinsic value and partially corrects undervaluation. Among overvalued firms, it widens the existing valuation gap and amplifies overvaluation. The association is significantly stronger among overvalued firms and among firms with direct consumer exposure. Instrumental-variable estimates yield similar results, although we interpret them cautiously because the exclusion restriction cannot be verified conclusively.

This study makes three contributions. First, it extends the green innovation literature by shifting attention from whether environmental innovation creates firm value to how equity markets incorporate that value into stock prices. This distinction is important because a favorable market response does not necessarily indicate an improvement in pricing accuracy. Second, the study shows that green innovation has asymmetric valuation consequences. The same upward response can partially correct undervaluation when market value is initially below intrinsic value but amplify overvaluation when market value is already above it. This evidence connects research on green innovation with the literature on innovation-related mispricing and behavioral responses to sustainability information (Bedford et al., 2021; Sirin, 2025; Yin and Xin, 2024). Third, we identify direct consumer exposure as a boundary condition shaping investors' responses to green innovation. Environmental innovation produces a stronger valuation response when it is more visible to consumers, the media, and non-specialist investors. The findings therefore show that the market consequences of green innovation depend not only on its economic content but also on firms' prior valuation positions and the visibility of their environmental initiatives.

The remainder of the paper is organized as follows: Section 2 reviews the relevant literature and develops hypotheses; Section 3 outlines the data and methodology; Section 4 presents and discusses the empirical results; and Section 5 concludes with a summary of findings, implications, and directions for future research.

Green innovation refers to the development or improvement of products, production processes, technologies, services, and management practices that reduce firms' environmental impacts (Bauweraerts et al., 2022; Fiorillo et al., 2022). It is particularly important in environmentally sensitive industries, where firms generate substantial environmental externalities and face close scrutiny from regulators and other stakeholders (Garcia et al., 2017; Naeem et al., 2022). These firms are under increasing pressure to reduce emissions, improve resource efficiency, and comply with changing environmental standards (Guo et al., 2023; He and Qiu, 2025). Green innovation is therefore both a response to external pressure and a strategic investment in firms' ability to manage environmental risks and remain competitive during the green transition.

Green innovation can create economic value through several channels. Process innovation can reduce energy and material use, improve production efficiency, and lower environmental compliance costs. Product innovation can support differentiation, access to green markets, and responses to changing customer preferences (Huang et al., 2023; Rahman et al., 2020). Green innovation may also demonstrate technological capability and regulatory preparedness while strengthening corporate reputation and stakeholder relationships (Chen et al., 2023a; Liu et al., 2024b; Rehman, 2025). Consistent with these benefits, prior research generally links green innovation to firm value, financial performance, and environmental performance, although the findings vary across institutional and firm-level settings (Hao et al., 2022; Cheng et al., 2025a, b; Liu et al., 2024a; Zheng and Iatridis, 2022). However, evidence of value creation does not establish that investors accurately incorporate this value into stock prices.

Accurate valuation is difficult because green innovation combines substantial current costs with uncertain and delayed benefits. Firms must invest in research, technology, infrastructure, and specialized human capital before the commercial outcomes of these investments become observable (Bauweraerts et al., 2022; Zhou et al., 2023). Their success depends on technological feasibility, future regulation, customer acceptance, and the firm's ability to appropriate the resulting benefits. Knowledge spillovers and environmental externalities create an additional complication because part of the social value generated by green innovation may not translate into firm-level cash flows (Aastvedt et al., 2021; Guo et al., 2023; Lv et al., 2023). Moreover, many of these investments are intangible and technically complex, while standardized valuation benchmarks remain limited. Investors may therefore recognize green innovation as favorable information without being able to determine its effects on expected cash flows and risk accurately (Fiorillo et al., 2022; Sirin, 2025; Yin and Xin, 2024).

Three related streams of research inform this valuation problem. The first examines the effects of green innovation on financial performance and firm value, but focuses mainly on whether it creates economic benefits rather than whether markets price those benefits accurately (Aastvedt et al., 2021; Hao et al., 2022; Zheng and Iatridis, 2022). The second links ESG performance and disclosure to equity mispricing (Bofinger et al., 2022; Wang et al., 2024; Yang et al., 2024). Aggregate ESG measures combine diverse environmental, social, and governance dimensions and may conceal the specific uncertainty associated with green innovation. The third examines the capital-market consequences of innovation, including stock liquidity, crash risk, and innovation-related mispricing (Ben-Nasr et al., 2021; Chen et al., 2023b; Sirin, 2025; Zaman et al., 2021). This literature establishes that markets can have difficulty pricing innovative activities, but provides limited evidence on green innovation in environmentally sensitive firms. The central issue is not only whether green innovation creates value, but also how investors price information that is favorable in direction yet uncertain in magnitude.

The Efficient Market Hypothesis provides a benchmark for understanding how green innovation should affect firm valuation. In an efficient market, investors incorporate available information into their estimates of future cash flows, growth opportunities, and firm risk. Market value should adjust in line with the underlying economic value of green innovation, while arbitrage limits persistent deviations from intrinsic value (Wang et al., 2024; Yang et al., 2024; Zhang and Yang, 2023). This process nevertheless depends on investors' ability to interpret the information correctly. The intangible assets, uncertain outcomes, and long investment horizons associated with green innovation increase information asymmetry and complicate fundamental valuation (Li, 2020; Fiorillo et al., 2022; Yin and Xin, 2024). Consequently, market prices reflect both expected economic benefits and investors' interpretation of the signal conveyed by green innovation.

Signaling theory explains why this interpretation is likely to be favorable. Developing environmental technologies, products, and processes requires financial resources, technical expertise, and sustained managerial commitment. Green innovation can therefore provide credible information about technological capability, strategic orientation, and preparedness for environmental transition (Fiorillo et al., 2022; Quan et al., 2025; Xiao et al., 2025). These capabilities can help firms improve operational efficiency, reduce regulatory exposure, strengthen their reputation, and capture emerging green-market opportunities (Chen et al., 2023a; Guo et al., 2023; Sirin, 2025). Because such capabilities are costly to develop and difficult to imitate, investors have an economic basis for revising firm valuation upward.

Valuation difficulty may magnify this upward response. Investors can often identify the favorable direction of a signal more easily than determine its appropriate economic magnitude. This problem becomes more pronounced when reliable benchmarks are unavailable and expected returns depend on uncertain technological and regulatory developments. Green innovation also supports salient narratives about technological leadership, regulatory advantage, sustainable growth, and corporate responsibility. Such narratives can attract investor attention and encourage optimistic expectations even when implementation costs, commercial risks, and the timing of future returns remain uncertain (Khan et al., 2024; Lin et al., 2023; Yin and Xin, 2024). Investors may then overweight prospective benefits and underweight technical and commercial risks. Market value may consequently increase more than estimated intrinsic value.

Signaling theory and behavioral finance thus provide complementary explanations for an upward valuation response. Green innovation conveys favorable information about firm capabilities and long-term prospects, while its complexity makes the appropriate magnitude of the response difficult to determine. The combination of positive information and valuation uncertainty is expected to increase market value relative to estimated intrinsic value. This prediction concerns the direction of the change in the ratio rather than its implication for pricing accuracy. Whether the change corrects or increases misvaluation depends on the firm's initial valuation position.

An increase in the market-to-intrinsic value ratio does not have the same implication across valuation states. For an undervalued firm, a higher ratio narrows the gap between market and intrinsic value and represents partial valuation correction. For an overvalued firm, the same increase widens the existing gap and reinforces the valuation distortion. A positive response to green innovation therefore cannot be interpreted uniformly as either improved pricing accuracy or increased misvaluation.

Undervaluation may occur when investors overlook the economic value of intangible and long-term investments. Green innovation requires substantial current expenditure, whereas its benefits from operational efficiency, regulatory preparedness, reputation, and growth opportunities emerge gradually. Investors may consequently give greater weight to immediate costs than to uncertain future gains (Aastvedt et al., 2021; Fiorillo et al., 2022; Yin and Xin, 2024). Prior research indicates that credible sustainability information can reduce undervaluation by revealing firm attributes that have not been adequately reflected in market prices (Benlemlih et al., 2021; Bofinger et al., 2022). Green innovation provides information about technological capability, managerial quality, and long-term strategic orientation. When these attributes were previously underappreciated, the resulting upward adjustment moves market value closer to estimated intrinsic value. For undervalued firms, a higher ratio indicates partial correction rather than greater misvaluation.

The effect differs among firms that are already overvalued. Their market values may be supported by optimistic growth expectations, favorable narratives, or heightened investor attention. Green innovation introduces an additional positive signal that aligns with these perceptions. Its prospective benefits are readily associated with sustainable growth and technological leadership, whereas its implementation costs, technical risks, and delayed returns are difficult to quantify. Investors may therefore place excessive weight on its upside potential (Khan et al., 2024; Lin et al., 2023; Yin and Xin, 2024). Demand from sustainability-oriented investors may strengthen this response by increasing interest in firms with strong environmental innovation profiles. Market value may consequently rise more than estimated intrinsic value, widening the existing valuation gap.

The upward response is expected to be stronger among overvalued firms. For undervalued firms, green innovation must counter unfavorable prior assessments. Uncertainty about its commercial outcomes may also make investors cautious, limiting the extent of valuation correction. Among overvalued firms, the same signal confirms prevailing optimism and supports already favorable expectations. Investors may respond strongly to its sustainability and growth potential while giving insufficient attention to implementation costs and downside risks. Green innovation is more likely to reinforce an optimistic valuation than to reverse a pessimistic one.

The valuation response to green innovation depends not only on its economic content but also on its visibility. Signaling theory suggests that a signal can influence investor beliefs only when external audiences can observe and interpret it. Stakeholder theory further indicates that environmental activities receive more attention when they are relevant to salient stakeholder groups, particularly consumers (Haddock-Fraser and Tourelle, 2010; Rahman et al., 2020). Green innovations communicated through products, brands, and public sustainability initiatives are therefore more likely to attract market attention than similar innovations embedded in internal operations. Greater visibility makes the favorable information conveyed by green innovation more accessible and increases the likelihood of a market response.

Green innovation is generally more visible in firms with direct consumer exposure. These firms can incorporate environmental attributes into products, packaging, services, advertising, and sustainability campaigns that consumers observe directly (Bauweraerts et al., 2022; Chen et al., 2023a). Environmental attributes can affect purchasing decisions and brand perceptions, giving consumer-facing firms stronger incentives to communicate their initiatives publicly (Haddock-Fraser and Tourelle, 2010; Rahman et al., 2020; Rehman, 2025). This communication expands exposure among consumers, the media, retail investors, and ESG-oriented investors. It can strengthen perceptions of the firm's environmental commitment, reputation, and future growth potential, producing a stronger valuation response.

Green innovation in industrial-facing firms is generally less visible to the broader market. It often involves cleaner production processes, resource-efficient technologies, pollution-control systems, improved interme

diate inputs, or supply-chain practices (Tang et al., 2018; Liu et al., 2024a). These initiatives may generate substantial economic and environmental benefits, but their technical and process-oriented nature makes them difficult for consumers and non-specialist investors to observe and evaluate. Their implications are more readily assessed by business customers, regulators, technical analysts, and other specialized stakeholders. Because these innovations receive less public attention, they are likely to generate weaker reputational and investor-attention effects.

Market visibility can affect valuation through informational and behavioral channels. Visible green innovation provides accessible information about technological capabilities, environmental strategy, and preparedness for regulatory transition. This information can help investors identify firm attributes that were previously overlooked and can facilitate the correction of undervaluation. At the same time, greater visibility increases the salience of favorable sustainability narratives and may attract attention beyond the innovation's economic importance (Lin et al., 2023; Yin and Xin, 2024). Investors may then overweight reputational and growth benefits while underweighting development costs, technological uncertainty, and delayed returns. Among overvalued firms, this response can reinforce existing optimism and widen the valuation gap. Visibility may therefore strengthen the upward response in both valuation states, although its consequences for pricing accuracy remain different.

We use the BC-BB classification to capture differences in direct consumer exposure and market visibility. This classification does not imply that firms follow mutually exclusive business models because some firms serve both organizational customers and end consumers. Rather, firms classified as BC are expected to have more observable and salient green innovations, whereas BB firms are treated as more industrial-facing. Direct consumer exposure increases stakeholder attention, signal visibility, and the salience of sustainability-related information. The positive association between green innovation and the market-to-intrinsic value ratio should consequently be stronger among BC firms.

We construct an international panel dataset of publicly listed firms operating in environmentally sensitive industries (ESIs) over the period 2002–2021. Following Meles et al. (2023), the initial sample comprises 1,422 firms ^[1]. We obtain the Environmental Innovation Category Score from the Thomson Reuters Eikon ESG database. Firm-level accounting and market data are collected from Worldscope, while analyst earnings forecasts used to estimate intrinsic value are obtained from the Institutional Brokers' Estimate System (IBES).

We merge the three databases at the firm-year level and retain observations with sufficient information to construct the market-to-intrinsic value ratio, green innovation measure, and control variables. Observations with missing values for any variable required in the corresponding regression are excluded. The resulting unbalanced panel contains 2,075 firm-year observations for 152 firms across 35 countries. Appendix 1 reports the distribution of observations by country and year, while Appendix 2 presents the firms included in the final sample. All continuous variables are winsorized at the 1st and 99th percentiles to reduce the influence of extreme observations.

To examine whether market visibility shapes the valuation response to green innovation, we classify firms according to their degree of direct consumer exposure. Following the approach of Haddock-Fraser and Tourelle (2010), the classification is based on a manual review of firms' websites, annual reports, and product descriptions. A firm is classified as BC when its principal products or services are marketed directly to end consumers and consumer-facing activities constitute a material part of its core business. Firms whose principal customers are manufacturers, distributors, governments, or other organizations are classified as BB. This classification is used as a proxy for differences in consumer exposure and market visibility; it does not imply that the two business models are mutually exclusive. The final sample includes 98 firms classified as BC, representing 1,333 firm-year observations, and 54 firms classified as BB, representing 742 observations.

Following Dong et al. (2006) and Cho et al. (2021), we measure firms' market valuation relative to estimated intrinsic value using the market-to-intrinsic value ratio (MSV):

where P_it is the market price per share and V_it is the estimated intrinsic value per share. An MSV value above one indicates estimated overvaluation, whereas a value below one indicates estimated undervaluation. Accordingly, a higher MSV does not necessarily represent a larger absolute valuation error. It indicates greater overvaluation when MSV>1, but a reduction in undervaluation when MSV<1.

We estimate intrinsic value using a three-period residual income valuation model:

where B_it denotes book value per share, FROE_i,t + j ​ is forecasted return on equity for year t+ j, and re_it ​ is the estimated cost of equity. Forecasted return on equity is calculated using IBES forecasted earnings per share and projected book value per share.

where FEPS_it+1denotes the consensus forecasted earnings per share for year t+1. Future book value per share is estimated as:

where k_it ​ is the dividend payout ratio, calculated as dividends per share divided by earnings per share. The cost of equity is estimated using the capital asset pricing model following Dong et al. (2006). Estimated costs of equity below 3% are set to 3%, whereas values above 30% are set to 30% (Bofinger et al., 2022; Dong et al., 2006).

Green innovation (GreenInv) is measured using the Environmental Innovation Category Score obtained from the Thomson Reuters Eikon ESG database. This score reflects the database's assessment of a firm's reported capacity to reduce environmental costs and create environmental opportunities through product and process innovation. Higher values indicate stronger reported environmental innovation performance (Fiorillo et al., 2022; Meles et al., 2023). Additionally, following earlier studies (Bofinger et al., 2022; Li, 2020; Sakaki et al., 2021), we incorporate control variables to account for factors influencing firm misvaluation. These include firm size (Size), proxied by the natural logarithm of the number of employees (Hao et al., 2022). Economies of scale may enhance firms' environmental performance, making green innovation more effective in larger firms (Zheng and Iatridis, 2022). Leverage (Lev), measured as the ratio of total liabilities to total assets, controls for firms' capital structure (Sakaki et al., 2021). Higher leverage may reduce financing costs and enhance firm performance (Fosu, 2013). Potential growth (Growth) is measured using the one-year sales growth rate (Li, 2020), as substantial growth may be associated with overinvestment and limits on arbitrage, both of which contribute to misvaluation. Profitability (ROA), measured as the ratio of net income to total assets (Bofinger et al., 2022; Li, 2020), provides insights into future returns and may influence stock return behavior, particularly under conditions of misvaluation. A comprehensive list of all variable definitions and their respective measurements is provided in Appendix 3.

We estimate firm fixed-effects regressions to control for unobserved time-invariant firm characteristics that may be correlated with both green innovation and market valuation. All regressions also include year fixed effects to absorb common shocks affecting firms in a given year. The baseline model is specified as follows:

where MSV_it ​ is the market-to-intrinsic value ratio of firm i in year t. We include the lagged dependent variable (MSV_it−1)​ to capture persistence in firm misvaluation. GreenInv_i,t−1 is the lagged environmental innovation score; and X_i,t−1 is a vector of lagged firm-level control variables, including Size, Lev, Growth, ROA, CapEx, and Div. Firm fixed effects are represented by μ_i, year fixed effects by λ_t, and the error term by ε_it. Standard errors are clustered at the firm level to allow for heteroskedasticity and arbitrary serial correlation within firms over time.

We further examine whether this association differs between observations classified as overvalued and undervalued. The overvalued and undervalued subsamples contain 514 and 1,561 firm-year observations, respectively. The subsample regressions allow the coefficient on GreenInv_i,t−1 ​ to be interpreted according to the direction of the valuation gap. A positive coefficient in the overvalued subsample indicates overvaluation amplification, whereas a positive coefficient in the undervalued subsample indicates undervaluation correction. The Chow test is used to assess whether the estimated regression coefficients differ across the two subsamples.

To address potential endogeneity between green innovation and firm misvaluation, we employ a two-stage least squares (2SLS) estimation approach. As an instrumental variable, we employ Policy_Emission, which captures the stringency of national-level climate policies based on the OECD Environmental Policy Stringency Index. Policy_Emission is correlated with firm-level green innovation, as stricter environmental policies incentivize eco-innovation. National climate policy stringency should not directly influence firm-level misvaluation, except through its impact on green innovation. The instrument operates at the macro-policy level and is exogenous to firm-specific market pricing. We further assess instrument strength using the first-stage F-statistic and conduct the Durbin-Wu-Hausman test for endogeneity.

Table 1 reports the descriptive statistics for the full sample and the overvalued and undervalued subsamples. The full sample comprises 2,075 firm-year observations. The mean MSV is 1.213, while its median is 0.948, indicating that the distribution is right-skewed and that the average is influenced by relatively high MSV observations. GreenInv has a mean of 55.760 and a standard deviation of 25.641, showing substantial variation in firms' environmental innovation scores. The average firm has leverage of 0.545, sales growth of 5.4%, ROA of 6.615%, and capital expenditure equal to 5.2% of total assets.

The descriptive statistics also reveal differences between the two valuation groups. The mean MSV is 2.018 in the ESI_Over ​ subsample and 0.948 in the ESI_Under ​ subsample. The mean GreenInv score is moderately higher among ESI Over ​ observations than among ESI_Under ​ observations (58.676 versus 54.799). The ESI_Over ​ group also exhibits higher average sales growth (6.6 versus 5.1%) and ROA (10.657 versus 5.284%), while having slightly lower leverage (0.518 versus 0.554). In contrast, firm size, capital expenditure, and dividend-paying status are broadly similar across the two groups. These differences are descriptive and do not establish whether green innovation affects firms' valuation outcomes; this relationship is examined in the subsequent multivariate analyses.

Table 2 presents the correlation matrix and variance inflation factors for the full sample. GreenInv is positively correlated with MSV, providing preliminary evidence of a positive association between environmental innovation performance and the market-to-intrinsic value ratio. However, the magnitude of this correlation is small. Among the control variables, ROA has the strongest correlation with MSV. The remaining correlations between the explanatory variables are also relatively low, with the largest being 0.257 between ROA and dividend-paying status. The VIF values range from 1.018 to 1.244, substantially below conventional thresholds. Therefore, multicollinearity is unlikely to materially affect the regression estimates.

Table 3 examines the relationship between lagged green innovation (GreenInv_t-1) and firm misvaluation (MSV). Column 1 reports the effect of green innovation on firm misvaluation using the full sample (ESI_Full). The coefficient for lagged green innovation (GreenInv_t−1) is positive (0.003) and statistically significant at the 1% level. This implies that a one-unit increase in a firm's green innovation score in the prior year increases misvaluation in the current year by 0.003, supporting Hypothesis 1. For a firm with an intrinsic value of $1 billion, this implies a $3 million increase in market valuation, indicating a deviation from intrinsic value.

These findings align with market inefficiency theory, particularly the roles of information asymmetry and cognitive biases. Green innovation may act as a signal, eliciting positive investor reactions that elevate market prices above intrinsic values, consistent with signaling theory. Given the uncertainty surrounding green innovation outcomes, investors may overreact to limited or ambiguous information, resulting in mispricing. Hence, the positive relationship suggests that green innovation contributes to misvaluation through signaling effects under conditions of asymmetric information.

Columns (2) and (3) show that this positive relationship appears in both valuation groups but differs substantially in magnitude. For overvalued firms, the coefficient on GreenInv_it-1 ​ is 0.007 and statistically significant at the 1% level. Stronger environmental innovation performance is associated with a further increase in market value relative to estimated intrinsic value. This finding is consistent with an amplification of existing overvaluation. Green innovation may generate favorable signals about firms' technological capabilities, future competitiveness, and environmental positioning. When these benefits are uncertain or difficult to value, optimistic investors may place greater weight on such signals, pushing market prices further above estimated intrinsic value.

For undervalued firms, the coefficient is smaller but remains positive and statistically significant at the 5% level. In this group, an increase in MSV represents a narrowing of the undervaluation gap rather than an increase in misvaluation. Green innovation may provide new information about managerial capability, operational improvements, and long-term growth opportunities that were previously underappreciated by the market. The reported Chow test indicates that the coefficients differ significantly between the two subsamples. The stronger coefficient among overvalued firms supports Hypothesis 2 and suggests that the valuation response to green innovation is asymmetric: it amplifies overvaluation more strongly than it corrects undervaluation.

Lagged MSV is positive and statistically significant in all three models, indicating persistence in firms' valuation positions. Its coefficient is largest among overvalued firms (0.377), followed by the full sample (0.226) and undervalued firms (0.107). Among the control variables, sales growth and ROA are negatively associated with MSV across all specifications. Size, leverage, and dividend-paying status are positively associated with MSV in the full and overvalued samples but are insignificant in the undervalued sample. Capital expenditure is positively significant only among undervalued firms, suggesting that physical investment may help improve market valuation relative to intrinsic value within this group. The results show that the implications of green innovation depend on firms' existing valuation status: the same positive change in MSV represents overvaluation amplification for overvalued firms but undervaluation correction for undervalued firms.

Figure 1 illustrates the estimated relationship between green innovation and MSV for the full sample and the two valuation subsamples. The positive slope is steepest for overvalued firms, indicating that greater green innovation is associated with a further increase in market value relative to intrinsic value and, therefore, a widening of overvaluation. The slope is also positive but considerably flatter for undervalued firms. Because predicted MSV remains below one in this subsample, this increase represents a narrowing of the undervaluation gap. The full-sample line captures the overall positive association between green innovation and MSV, combining these two economically distinct valuation responses.

Table 4 reports the effects of green innovation on firm misvaluation for BB firms (columns 1–3) and BC firms (columns 4–6). The coefficient of lagged green innovation (GreenInv_t-1) is significantly positive in most specifications, indicating that green innovation increases misvaluation in the subsequent period. The Chow test confirms that this effect is significantly stronger for overvalued firms (ESI_Over) than for undervalued firms (ESI_Under), particularly in the BC sample.

For BC firms, the positive impact of green innovation on misvaluation is three times larger for overvalued firms than the corresponding reduction for undervalued firms. In contrast, for BB firms, green innovation significantly increases misvaluation only among overvalued firms, with no discernible effect on the undervalued group. These findings are consistent with the earlier results in Table 3 and provide further support for Hypothesis 2.

A comparison of GreenInv coefficients across panels shows that the overall impact of green innovation on misvaluation is approximately 1.5 times greater in BC firms (Table 4, Column 4) than in BB firms (Column 1). Moreover, the effect on overvaluation is 1.2 times more pronounced in BC firms (Column 5) than in BB firms (Column 2), whereas a significant effect on undervaluation appears only in BC firms (Column 6). Collectively, these results confirm that green innovation has a stronger influence on misvaluation dynamics in BC firms, thereby supporting Hypothesis 3.

This asymmetry reflects the nature of BC firms, where green innovation, such as eco-friendly products or visible sustainability initiatives, is more observable and more impactful for end consumers. These initiatives often directly influence consumer purchasing decisions and brand loyalty, potentially translating into higher sales and market share. As such, they generate clearer and stronger market signals, attracting investor attention and fostering optimism, thereby driving misvaluation. In contrast, green innovation in BB firms typically involves internal process improvements or supply chain sustainability, which may be less visible and harder for the market to evaluate. The lower salience of these innovations limits their signaling power and reduces the likelihood of significant sentiment-driven market reactions.

Furthermore, green innovation can reduce information asymmetry and attract sustainability-oriented investors. However, due to its complex and often incomplete nature, innovation-related information may be misinterpreted or selectively weighted, especially by retail investors. In BC firms, where green initiatives are more transparent and easier to interpret, this can enhance the cognitive bias premium, amplifying investor sentiment and contributing to misvaluation. In contrast, the lower visibility and complexity of green innovation in BB firms may result in more subdued market responses and weaker valuation distortions.

In efficient markets, firms with stronger innovation capacity and sustainability performance tend to be more highly valued by investors (Dong et al., 2021). This valuation premium raises concerns about endogeneity between green innovation and firm misvaluation. To mitigate this potential endogeneity, we employ a 2SLS approach, using Policy_Emission as an instrumental variable (IV) for GreenInv (Zaman et al., 2021). Policy_Emission is a binary variable equal to 1 if a firm discloses an explicit emission policy, and 0 otherwise. Such policies are linked to internal environmental innovation efforts but are arguably exogenous to contemporaneous stock price misvaluation, thereby satisfying the relevance and exclusion restrictions for valid instrumentation. The instrument is sourced from the Thomson Reuters Eikon ESG database.

Table 5 presents the 2SLS estimates for the full sample (ESI_Full) and the two subsamples (ESI_Over and ESI_Under). The coefficient of lagged GreenInv_t-1 remains positive and statistically significant across all models, indicating that green innovation continues to increase firm misvaluation even after controlling for potential endogeneity. The larger coefficient estimates in the IV specification suggest that baseline models may underestimate the impact of green innovation on valuation distortions due to omitted variable bias or reverse causality. These findings reinforce the argument that the informational complexity, uncertainty, and signaling characteristics of green innovation may contribute to persistent valuation deviations. Rather than improving pricing efficiency, the evidence suggests that sustainability-related innovation may intensify valuation distortions under conditions of market inefficiency and investor sentiment. Notably, the effect is strongest in the ESI_Over sample (coefficient = 0.029, t = 3.858), suggesting that sustainability-related innovation signals more strongly influence firms with optimistic market sentiment and elevated valuations. This finding is consistent with behavioral finance arguments that investors may overreact to salient sustainability-related information, thereby amplifying existing valuation distortions.

We verify instrument strength through the first-stage F-statistics. Across all panels, the F-statistics, 17.984, 12.482, and 17.571 (all significant at the 1% level), exceed the Stock–Yogo critical value of 10, alleviating concerns about weak instrumentation. The coefficient of Policy_Emission is positive and statistically significant, affirming its relevance. Moreover, the Durbin–Wu–Hausman test yields statistics of 2.050, 1.959, and 2.065 in the second-stage regressions, indicating the presence of endogeneity and justifying the use of 2SLS over OLS.

The empirical results reveal a significant asymmetry in how green innovation affects market pricing. The coefficient for lagged green innovation is substantially larger for overvalued firms than for undervalued firms, indicating that green innovation amplifies overvaluation more than it corrects undervaluation. This finding is consistent with behavioral finance literature suggesting that investors may overreact to salient sustainability-related signals, particularly when firms already benefit from optimistic market sentiment. Similar to Khan et al. (2024) and Yang et al. (2024), our results suggest that ESG-related narratives can intensify investor enthusiasm and speculative pricing dynamics. However, our findings differ from strands of ESG literature that suggest sustainability activities primarily improve informational transparency and pricing efficiency. While green innovation may partially reduce undervaluation by signaling managerial capability, long-term strategic orientation, and future growth potential, the dominant effect in our sample is the intensification of overvaluation.

The findings further show that the association between green innovation and misvaluation is significantly stronger among BC firms than among BB firms. This result is consistent with prior evidence that sustainability initiatives attract greater market attention in consumer-facing firms because they are more visible to customers, the media, and retail investors (Rahman et al., 2020; Chen et al., 2023a). From a stakeholder theory perspective, BC firms can use green innovation to enhance their brand image and environmental reputation. This visibility strengthens the market signal generated by green innovation but may also amplify investor sentiment and produce larger valuation distortions. By contrast, green innovation in BB firms is often process-oriented and less observable to external stakeholders, resulting in weaker market reactions and smaller valuation distortions.

More broadly, this study contributes to the emerging literature on ESG-related market anomalies by identifying green innovation as a signal with both informational and distortionary effects. Much of the existing literature emphasizes that sustainability disclosure and ESG engagement improve transparency and reduce information asymmetry (Bolognesi and Burchi, 2023). Our findings provide a more nuanced perspective by showing that green innovation, due to its intangible nature, technical complexity, and uncertain long-term outcomes, may hinder investors' ability to accurately assess firm value. These challenges are further amplified by concerns regarding selective disclosure and ESG greenwashing, which can impair the information environment and weaken pricing accuracy (Lin et al., 2023). The evidence suggests that complex sustainability-related signals may not always be processed efficiently by capital markets.

This study examines the relationship between green innovation and firm misvaluation, with particular attention to differences between overvalued and undervalued firms and between BB and BC firms in environmentally sensitive industries. The findings show that green innovation is associated with a higher market-to-intrinsic value ratio. However, this increase has different implications depending on firms' initial valuation status. It amplifies overvaluation among overvalued firms but reduces the valuation gap among undervalued firms. The association is also significantly stronger for BC firms than for BB firms. These findings demonstrate that the valuation consequences of green innovation depend on both existing valuation status and market visibility.

First, the asymmetric results are consistent with behavioral finance and investor psychology. For overvalued firms, favorable green innovation signals may reinforce investor optimism and lead investors to place excessive weight on expected environmental and commercial benefits. This response can push market prices further above estimated intrinsic value. For undervalued firms, the same signals may provide information about previously underappreciated technological capabilities and growth opportunities, bringing market value closer to intrinsic value. Green innovation therefore amplifies existing overvaluation more strongly than it corrects undervaluation.

Second, visibility and salience theories help explain the stronger misvaluation effect observed in BC firms. Because BC firms embed green initiatives in consumer-facing products and marketing campaigns, green innovation becomes highly visible and emotionally resonant for retail investors. This transparency strengthens the signaling effect and reinforces cognitive biases, including the representativeness and affect heuristics, thereby intensifying investor sentiment and market mispricing. In contrast, green innovation in BB firms tends to be more process-oriented and less visible to non-specialist investors, resulting in weaker investor reactions and lower valuation distortions. This finding is consistent with international evidence showing stronger investor responses to ESG initiatives (Bofinger et al., 2022; Yang et al., 2024) and ESG disclosures (Wang et al., 2024; Wu et al., 2024) in consumer-facing firms because of greater information salience.

The findings also carry important implications for policymakers, investors, and corporate managers. For regulators, the stronger misvaluation effect in BC firms highlights the importance of more standardized and verifiable green innovation disclosures. Regulatory frameworks should encourage consistent and credible reporting practices to reduce investor misinterpretation and potential asset mispricing.

Retail and institutional investors should recognize the psychological and behavioral biases triggered by emotionally salient sustainability signals, especially in BC settings. Investors should conduct more rigorous due diligence and fundamental analysis to avoid overvaluing green narratives that may not yet produce tangible performance improvements.

This study has several limitations. First, green innovation is measured using the Thomson Reuters Eikon Environmental Innovation Score. Although this measure is widely used, it is available for a limited number of firms and primarily reflects reported environmental innovation performance. It may therefore constrain the sample size and may not fully capture firms' actual innovation activities. Future studies could employ more objective and detailed measures, such as green patents, patent citations, and environmental R&D expenditures. These indicators may also help distinguish substantive innovation from symbolic environmental claims. Second, the sample period also includes the COVID-19 pandemic, which generated substantial market volatility and shifts in investor sentiment toward ESG-related activities. Although year fixed effects help mitigate common time-specific shocks, pandemic-related behavioral dynamics may still affect the market valuation of green innovation. Future research could examine whether the valuation consequences of green innovation differ between the pre-pandemic, pandemic, and post-pandemic periods.

The supplementary material for this article can be found online.