Grantee Research Project Results
2005 Progress Report: Pollution Prevention: The Role of Environmental Management and Information
EPA Grant Number: R830870Title: Pollution Prevention: The Role of Environmental Management and Information
Investigators: Khanna, Madhu , Deltas, George , Joshi, Satish
Institution: University of Illinois Urbana-Champaign , Michigan State University
Current Institution: University of Illinois Urbana-Champaign
EPA Project Officer: Hahn, Intaek
Project Period: May 30, 2003 through May 29, 2006 (Extended to May 29, 2007)
Project Period Covered by this Report: May 30, 2005 through May 29, 2006
Project Amount: $286,539
RFA: Corporate Environmental Behavior: Examining the Effectiveness of Government Interventions and Voluntary Initiatives (2002) RFA Text | Recipients Lists
Research Category: Environmental Justice , Pollution Prevention/Sustainable Development
Objective:
The purpose of this research is to examine whether and to what extent the adoption of Total Quality Environmental Management (TQEM) is fostering pollution prevention (P2) activities and its implications for the environmental performance and economic performance of firms. These issues will be investigated using a sample of S&P 500 firms that emit toxic releases. More specifically, this research will:
(1) Develop a theoretical framework to examine the incentives provided by the market for firms to produce greener products and its implications for the ability of the market to achieve social optimality. We will examine the implications of consumer preferences for product quality and social welfare and the supplementary regulatory policies needed to achieve social optimality.
(2) Empirically examine the extent to which TQEM and information provision have been effective in motivating the adoption of P2 activities, and whether P2 adoption is improving environmental performance. We will examine if P2 adoption is occurring in response to adoption of TQEM and information provision about toxic releases and P2 activities and the types of P2 activities being adopted. This analysis will control for differences in various firm- and industry-specific attributes and direct regulatory and market pressures to adopt P2.
(3) Examine the implications of TQEM and P2 for the economic performance of firms. We will examine the sources of economic benefits, such as higher market share, higher price earnings ratio, and abnormal changes in stock market returns for firms that adopt TQEM and/or P2 and whether stock market reactions to the environmental information in the Toxics Release Inventory (TRI) are influenced by information about toxicity of releases and about TQEM and P2 activities.
Progress Summary:
Firm Level Analysis of the Type of P2 Practices Promoted by TQEM
In the third year of this project, we have been focusing on achieving objective 2 of the proposal and have done preliminary work on objective 3. We are developing an empirical framework to examine the effect of TQEM on the adoption of 43 types of innovative P2 activities over the period 1992-1996, and to determine whether the effect of this management system differs systematically across innovation types. We are differentiating innovations according to their functional characteristics: whether they involve procedural changes, equipment modifications, material modifications, or other unclassified/customized changes; their visibility to consumers; and their ability to enhance efficiency. To control for differences across firms in terms of other pressures for adoption of P2 activities, such as regulatory or nonregulatory pressures, we include firm-specific, practice-specific, and year-specific fixed effects. We find that the effect of TQEM on P2 is nonuniform. TQEM supports the adoption of practices that involve procedural changes or have unclassified/customized attributes. We also find that the visibility to consumers or efficiency enhancement does not incrementally contribute to the effect of TQEM on the adoption of P2 practices. Moreover, we find the timing of TQEM adoption or any type-specific trends in the adoption of P2 activities are not driving the above findings. Simulations show that 16 percent of the count of P2 activities adopted by firms can be attributed to the organizational structure inherent in TQEM. The P2 activities most strongly affected by TQEM are those involving product modifications, spill and leak prevention, and raw material modifications. Because these types of P2 activities are more prevalent in the petroleum refining and chemical manufacturing industries, these sectors experience the largest impact of TQEM on their P2 activities. The petroleum industry (SIC 13) accounts for 2 percent of toxic emissions and 2 percent of net sales within our sample of S&P 500 firms over the period 1992-1996. The chemical manufacturing industry (SIC 28) accounts for 47 percent of toxic releases and 13 percent of total sales within our sample of S&P 500 firms between 1992-1996.
Facility Level Analysis of the Impact of P2 on Toxic Releases
In addition to the above, we have made progress with analyzing the effects of P2 adoption on toxic releases. To undertake this analysis, we collected a long panel data for the period 1991-2001 at the facility level. We compiled data on the P2 practices adopted, on the toxic releases emitted, and on proxies of regulatory and nonregulatory pressures faced by 4,225 facilities belonging to S&P 500 firms that reported to TRI over this period. The regulatory and nonregulatory pressures include whether the state had a voluntary or mandatory P2 program, nonattainment status of the county, the frequency of penalties and inspections faced by the facility, the number of Superfund sites for which the facility is listed as potentially responsible, and community characteristics of the county where the facility is located.
We estimate a regression equation with toxic releases of a facility at time t as the dependent variable and a function of lagged toxic releases, of its P2 practices currently, and various regulatory and nonregulatory pressures that could affect toxic releases. We have to address several econometric issues in estimating this equation. First, is the potential endogeneity of the count of P2 practices adopted; second, the inclusion of facility-specific and time-specific fixed effects; and third, the potential endogeneity introduced by the inclusion of lagged toxic releases as an explanatory variable in a model with facility-specific fixed effects. The reason for the latter is that a standard fixed effects estimator involves estimating an equation in which all variables are expressed as deviations from their mean over time. Because the mean of the lagged dependent variable (toxic releases) contains in it all the time specific error terms for that facility, the deviations from the mean are still endogenous.
To address the endogeneity of the count of P2 practices adopted, we estimate first-stage regressions to determine the variables that can be used as instruments for P2 practices. Because we have a count variable and because a large number of facilities had adopted zero practices, we explore several alternative models, such as a Poisson, a Negative Binomial, and a Zero-Inflated Poisson Model. We also estimate models that allow us to distinguish between the determinants of the decision of whether or not to adopt any P2 practice and the number of P2 practices adopted. We also use firm-specific rather than facility-specific fixed effects to control for unobserved financial, managerial, and cultural factors that could influence facility behavior and to avoid the problem of endogeneity mentioned above. Our initial results show facilities located in nonattainment areas, in states with voluntary or mandatory P2 programs, and in counties that are primarily democratic and have a strong presence of environmental interest groups are more likely to adopt P2 practices. Our results are fairly robust across the different specifications we estimate. We also find strong evidence that adoption of more P2 practices reduces the toxic releases of the facility. We are continuing to refine our models and specifications and check the robustness of our results.
Relationship Between Financial and Environmental Performance of Firms
Furthermore, we completed the compilation of panel data at the firm level to explore the impact of toxic release emissions and P2 activities on the financial performance of firms. We compiled data on financial variables at the firm level for S&P 500 firms that report to TRI for the period 1991-2001 and merged them with data on P2 practices adopted and toxic emissions. We completed a review of the recent literature in this area. Based on that review, we have chosen two measures of financial performance. The first is Tobin’s q, which has been used commonly in the literature, and the second is the Price/Earnings Ratio. The Price/Earnings ratio would allow us to capture demand side effects on stock prices (driven by investor preferences for green firms) as well as the effects of pro-environmental activities on earnings of a firm. This is preferable to using the Tobin’s q, which does not have a direct link to the earnings of a firm. Previous studies also have used abnormal returns on the day of an announcement about a firm’s environmental performance. By using Price/Earnings ratio or Tobin’s q we hope to better examine longer term effects of environmental performance on financial performance and also to control for firm-specific effects using panel data models. We are conducting econometric analysis of the role of environmental performance, measured by toxic releases, count of P2 practices, and number of Superfund sites at which the firm is potentially responsible as a determinant of Tobin’s q and Price/Earnings ratio, in addition to other standard control variables.
Theoretical Analysis of the Role of Public Policies in Motivating the Provision of Green Goods
Continuing our theoretical work examining the incentives for heterogeneous duopolistic firms to provide green goods, we now develop a theoretical framework to examine the role of public policy in motivating firms to provide greener goods. Our earlier research showed that even if consumers are willing to fully internalize the externalities of their consumption decisions, there is underprovision of green goods because of price competition between firms. We now are examining the design of cost-share subsidies and a minimum quality standard to provide greater incentives to firms to increase the greenness of their goods.
Cost-sharing subsidies reduce the cost of undertaking quality improvements, by reducing the actual out-of-pocket expense by the firm. If left on their own, firms would simply choose the level of environmental quality of their product that maximizes their profit (i.e., one that maximizes the revenue from selling their green product less the cost of developing the green attribute). From society’s perspective, however, there are gains from producing green goods beyond the value of sales that accrues to the firm. Cost-sharing subsidies are meant to lower the cost of developing and providing greener products, in the same way that the production of a dirtier good is taxed. These subsidies, therefore, account for the positive externality of a firm’s green production and are meant to induce firms to produce goods with higher environmental quality than what they would produce if they were to bear the entire cost of developing more environment friendly products.
The interesting case in environmental regulation through cost-sharing subsidies is when firms have asymmetric costs of improving environmental quality and they choose different levels of environmental quality of their products. In such a case, the social-welfare maximizing environmental quality levels are such that they are higher for the firm with a lower cost of environmental quality improvement, all other things equal. The firm that can achieve higher environmental quality at lower cost, is at the optimum, the one that should produce the greener good. The optimal cost-share subsidy scheme would therefore be one that provides a different subsidy rate to each firm, depending on their costs. A uniform cost-share subsidy ignores the fact that one firm can more cheaply produce higher levels of environmental quality than the other firm. If the uniform subsidy is set at the average of the ideal and optimal differentiated subsidy rates, it would under-subsidize the firm that can actually produce higher environmental quality, and over-subsidize the one that produces lower quality.
Our initial analysis shows that differentiated cost-share subsidies can increase social welfare and the greenness of goods, whereas a uniform subsidy may not lead to the socially desirable mix of environmental quality from the products of the two firms. We now are examining whether the combination of a uniform cost-share subsidy and a minimum quality standard can achieve a higher level of social welfare than either of these two policies alone.
Future Activities:
There are three major objectives of research in the coming year.
First, we plan to complete our analysis of the role of subsidies and quality standards on incentives to provide green goods. We also are planning to consider the case where consumers cannot perfectly observe the environmental attributes of products. Firms may adopt TQEM to provide a signal of their environmental stewardship to consumers. We plan to analyze the incentives for firms to produce greener products in this case and whether TQEM adopters are more likely to produce a greener product. We also plan to examine whether government incentives targeted towards inducing TQEM are more or less effective than incentives provided for actually improving product greenness.
Second, we plan to complete our analysis of the motivators for P2 using the facility level data and examine the implications of P2 for toxic release performance.
Third, we plan to complete our analysis of the extent to which P2 and other environmental performance measures affect the economic performance of firms, measured by two alternatives variables, such as Tobin’s q and the Price/Earnings ratio of the firm.
Journal Articles:
No journal articles submitted with this report: View all 36 publications for this projectSupplemental Keywords:
toxic releases, good operating practices, process and product modifications, waste, spill and leak prevention, technological innovativeness, information disclosure, SIC codes 13, 20, 26, 28, 29, 33, 34, 36, 37, 38, 45, 48, 49, 50, 51, 54, 59, 72, 73,, RFA, Economic, Social, & Behavioral Science Research Program, Scientific Discipline, Sustainable Industry/Business, cleaner production/pollution prevention, Corporate Performance, Economics and Business, decision-making, Economics & Decision Making, environmental management systems (EMS), corporate decision making, environmental management systems, toxic release inventory, decision making, pollution prevention assessment, corporate compliance, cost benefit, environmental evaluation, behavior change, outreach and education, pollution prevention, EMS, environmental behavior, benefits assessment, corporate environmental behavior, corporate cultureProgress and Final Reports:
Original AbstractThe perspectives, information and conclusions conveyed in research project abstracts, progress reports, final reports, journal abstracts and journal publications convey the viewpoints of the principal investigator and may not represent the views and policies of ORD and EPA. Conclusions drawn by the principal investigators have not been reviewed by the Agency.