Environmental Compliance and Firm Performance: Evidence from China*
| Published date | 01 June 2012 |
| Author | Yang Yao,Xi Yang |
| Date | 01 June 2012 |
| DOI | http://doi.org/10.1111/j.1468-0084.2011.00649.x |
397
©Blackwell Publishing Ltd and the Department of Economics, University of Oxford, 2011. Published by Blackwell Publishing Ltd,
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OXFORD BULLETIN OF ECONOMICS AND STATISTICS, 74, 3 (2012) 0305-9049
doi: 10.1111/j.1468-0084.2011.00649.x
Environmental Compliance and Firm Performance:
Evidence from ChinaÅ
Xi Yang† and Yang Yao‡
†Department of Economics, Johns Hopkins University, Baltimore, MD, USA
(e-mail: xyang31@jhu.edu)
‡China Center for Economic Research, National School of Development, Peking University,
Beijing 100871, China (e-mail: yyao@ccer.pku.edu.cn)
Abstract
This article evaluates the impact of environmental compliance on firms’ innovation and
financial performance using a panel dataset of Chinese firms for the period of 2000–5. Our
results show certification of the ISO14000 has a significantly positive impact on firms’
profitability. This finding is robust when we take into account possible endogeneity of
certification, effects of export and types of customers, and possible precertification time
trends. In addition, we find that certified firms have larger per-worker sales volumes and
market shares in the country, which suggests an alternative mechanism for the Porter
hypothesis in the context of a developing economy.
I. Introduction
Environmental degradation poses a serious challenge to China’s fast economic growth.
Despite well-conceived laws, enforcement varies tremendously on the ground (Wanget al.,
2003; Wangand Wheeler, 2005). Local governments’ focus on economic growth and firms’
resistance towards additional compliance have both contributed to weak implementation
(SEPA, 2006). Even when local governments have the will to push for environmentally
friendly policies, regulations often end up a game of ‘cats and mice’ in which firms find
ways to evade the regulatory agencies. In light of this dire situation, it is important to pro-
vide firms a business case for greater environmental compliance. This article is an effort
to find empirical evidence for positive links between environmental compliance and firm
profitability using a recent panel survey of 1,200 firms from 12 Chinese cities.
The measure of environmental compliance is ISO14000 certification in our article.
The ISO14000 is comprised of a series of standards and is accepted by 111 countries. Its
ÅWe thank two anonymous referees, Robert Elliot, Hanming Fang, Yi Kang, Weicheng Lian, Yan Shen, Linda
Yueh, Yaohui Zhao, participants of the development economics workshops in CCER at Peking University, and
participants of ‘The Microeconomic Drivers of Growth in China’ conference held in the University of Oxford on
29–30 September 2008 for their helpful comments and suggestions. We are grateful for the efforts of the National
Development and Reform Commission and National Bureau of Statistics, the People’s Republic of China in helping
collecting the data and the International Finance Corporation for its permission to use the data. Wealso thank Linda
Yuehfor providing part of the data. Of course, all errors remain ours.
JEL Classification numbers: O31, Q52, Q55.
398 Bulletin
backbone is the ISO14001 Environmental Management System (EMS). Certification is
voluntary; firms can be certified by successfully passing an independent third-party audit.
The standard was launched in China in September 1996.
We focus on the ISO14000 for several reasons. First, it is an international standard
for environmental management that applies to all countries and all industries. Second,
certified firms are subjected to audits by a third party for the duration of the certification.
These two reasons make the standard a comparable and objective measure of environmental
compliance across industries and regions. Third, the standard puts comprehensive and spe-
cific requirements on certified firms. Getting certified involves substantial preparation and
re-engineering of the management structure and production process which taken together
is likely to raise the level of environmental compliance within a firm. Lastly, although most
previous studies (see some of the papers reviewed in section II) used pollution emissions
and expenditures on environmental protection to measure firms’ environmental perfor-
mance, this kind of data is unreliable in developing countries; using an objective measure
like ISO14000 certification is a better alternative.
We first study the link between ISO14000 certification and firm profitability to estab-
lish a business case for environmental compliance. Then we study the mechanisms by
which the ISO14000 certification generates positive effects on firm profitability.The Porter
hypothesis (Porter, 1991; Porter and van der Linde, 1995) suggests that the ‘innovation
mechanism’ in the form of more stringent environmental regulation (or better compliance
in our case) induces firms to innovate when benefits can more than offset compliance costs.
To test whether this mechanism exist, we use firms’R&D expenditure and number of pat-
ents as the outcome variables. As an alternative, we also test the ‘marketing mechanism’
through which ISO14000 certification help firms to gain larger market shares because it
could serve as a signal of their managerial and technical competence which is unobserved
by customers but affects product quality as well as their ability to meet customer require-
ments on environmental standards. This mechanism may be more important in developing
countries because the degree of environmental compliance is low in those countries.1
We aim at making two contributions to the literature. The first is to provide a business
case for voluntary environmental compliance in a developing country. With the exception
of a few (e.g. Murty and Kumar, 2003), most existing studies focus on developed coun-
tries. But environmental compliance could be different in developing countries than in
developed countries. On the one hand, it is relatively more expensive in developing coun-
tries because firms there are usually smaller than their counterparts in developed countries
in terms of sales and profits. On the other hand, better compliance can easily single out a
firm and enhance its market competitiveness in a developing country where environmental
compliance is heterogeneous across the board.
The second and perhaps more important contribution we want to make, is to take into
account the endogeneity of firms’ decisions on environmental compliance. As shown by
Wang and Wheeler (2005) on China, the degree of environmental compliance is a joint
result of government regulation and firm initiatives. The cost of abating technology is
usually fixed, but pollution and thus government fines increase with output, so the relative
1Our marketing mechanism is different from Porter’s assessment that more stringent environmental regulation
could enhance domestic companies’ competitiveness in the international market because this added competitiveness
is caused by better technology in his argument.
©Blackwell Publishing Ltd and the Department of Economics, University of Oxford 2011
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