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Environmental Innovations and Firm Profitability: Unmasking the Porter Hypothesis

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Abstract

We examine impacts of different types of environmental innovations on firm profits. Following Porter’s (Sci Am 264(4):168, 1991) hypothesis that environmental regulation can improve firms’ competitiveness, we distinguish between regulation-induced and voluntary environmental innovations. We find that innovations which do not improve firms’ resource efficiency do not provide positive returns to profitability. However, innovations that increase a firm’s resource efficiency in terms of material or energy consumption per unit of output have a positive impact on profitability. This positive result holds for both regulation-induced and voluntary innovations, although the effect is greater for regulation-driven innovation. We conclude that the Porter hypothesis does not hold in general for its “strong” version, but depends on the type of environmental innovation. Our findings rest on firm-level data from the German part of the Community Innovation Survey 2008 (CIS 2008).

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Notes

  1. Christainsen and Haveman (1981), for instance, attribute 8–12 % of the U.S. productivity slowdown between 1965 and 1979 to environmental regulation. More evidence is documented in Gollop and Roberts (1983), Gray (1987), and more recently in Greenstone (2002). Another strand of the literature looks on regulation impacts on plant births and location choice that also finds negative effects of regulation, see Henderson (1996), Becker and Henderson (2000), List et al. (2003), and the survey of Brunnermeier and Levinson (2004).

  2. In their paper, André et al. (2009) assume quality competition between two firms, the higher quality product being associated with less environmental damage. If environmental regulation forces both firms to adopt the higher quality good, they can both increase profits and lower environmental pressure. The reason for this is that “regulation [...] acts mainly as a cartellizing device for firms, allowing them to sustain a substantially higher equilibrium price (and serve a smaller fraction of demand)....” (André et al. 2009, p. 188).

  3. Note that the literature provides also some evidence for a crowding out of productive investments by environmental innovations, see for instance Gray and Shadbegian (1998) for the pulp and paper sector. More recently, Popp and Newell (2012) find that an increase in clean energy patenting of firms is associated with a decrease in patenting activities regarding other technologies. This effect not due to financial constraints of firms but due to profit seeking research opportunities and hence does not imply a crowding out.

  4. Some studies argue that environmental regulation can also increase market power and thus prices. Firms that produce pollution-intensively are typically rather capital-intensive producers with high fixed costs. If regulation requires the use of abatement technologies, capital requirements may increase, leading to restricted competition because of high minimum efficiency plant sizes, which might deter market entry. Regulation may hence promote collusion; see Buchanan and Tullock (1975) among many others. In what follows, however, we do not model this relationship.

  5. NACE denotes the European industry classification system (Nomenclature statistique des activités économiques dans la Communauté européenne) and is based on the International Standard Industrial Classification Rev. 4 (ISIC 4).

  6. The studies by Konar and Cohen (2001) and Canõn-de-Francia et al. (2007), for instance, use data of firms listed at the stock market, which predominantly include large firms. Rassier and Earnhart (2010) use data of publicly owned firms.

  7. Note that the firms report information on return on sales based on their accounting records. A potential weakness of accounting based information is that it does not entirely reflect firm performance due to efficiency. This is because profits from non-operational business activities are also accounted for (e.g. depreciations and profits or losses from participation in other firms).

  8. The results of the Heckman selection model are available from the authors upon request.

  9. In our sample, 48.3 % of firms that introduced environmental innovations reported not to have conducted any in-house R&D activities at all. Moreover, it is rather unlikely that many firms invented their own pollution abatement technologies since this is not the core business. Thus, most firms are likely to be adopters of technology provided by others, namely specialised technology suppliers as Pavitt (1984) puts it.

  10. Note that in the German version of the CIS 2008, firms were offered a four point Likert scale (no, small, medium, and high environmental impacts) to reply whereas in the standard CIS questionnaire, only yes/no options were given. In order to make our results comparable to other studies using CIS 2008 data, we rearranged the responses into binary indicators equal to one if at least a small environmental impact is observed.

  11. The regression results appear to be robust against the exclusion or inclusion of this type of environmental innovation.

  12. There are several explanations for voluntary over-compliance and why it likely increases returns to technology adoption or profitability in general exist. One is that voluntary over-compliance offers customers further utility from consuming environmentally-friendly produced products (Arora and Cangopadhyay 1995). Empirical support is provided by Arora and Cason (1995) showing that firms in less concentrated sectors with more competition are more likely to participate in voluntary environmental programs. Another argument is as follows: environmental standards may limit entry because of increasing sunk costs and therefore stimulate concentration in regulated sectors (Buchanan and Tullock 1975). Because concentration is associated with higher profits, firms may have an incentive to over-comply (especially in cases when the use of the best available technology is demanded) as to force policymaker to tighten environmental standards and to raise the costs of their competitors that need to comply (Salop and Scheffman 1983).

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Authors and Affiliations

  1. Centre for European Economic Research (ZEW), L7,1, 68161 , Mannheim, Germany

    Sascha Rexhäuser & Christian Rammer

  2. Katholieke Universiteit Leuven (KU Leuven), Naamsestraat 69, 3000 , Leuven, Belgium

    Sascha Rexhäuser

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  1. Sascha Rexhäuser
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  2. Christian Rammer
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Correspondence to Sascha Rexhäuser.

Additional information

We thank David Popp and three anonymous referees for very helpful comments and suggestions that improved the paper substantially. Moreover, we thank Klaus Rennings, Michael Schymura, and Konrad Stahl for comments on an earlier version of this paper and we thank Diana Klukas for excellent research assistance. This research was done within the framework of the research program “Strengthening Efficiency and Competitiveness in the European Knowledge Economies” (SEEK). We gratefully acknowledge funding from the government of Baden-Württemberg.

Appendix: German CIS Firm Survey from 2009

Appendix: German CIS Firm Survey from 2009

See Table 9.

Table 9 Original questions from the firm survey
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Rexhäuser, S., Rammer, C. Environmental Innovations and Firm Profitability: Unmasking the Porter Hypothesis. Environ Resource Econ 57, 145–167 (2014). https://doi.org/10.1007/s10640-013-9671-x

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