Toxic Emissions and Corporate Green Innovation 

By | November 29, 2022

One negative consequences of industrialization has been the generation and release of toxic chemicals, which have detrimental effects on the environment, climate, and public health. As the world grapples with environmental and climate change challenges, these byproducts are becoming an important issue drawing the attention of investors, scholars, and governments. For instance, toxic emissions are an important component of Environmental, Social, and Governance (ESG) scores (e.g., MSCI & Sustainalytics) used by investors and other market participants worldwide. Prior research has also shown that investors demand a significantly higher rate of return, and banks charge a higher interest rate on loans for firms with higher toxic emissions. Recently, the U.S. Environmental Protection Agency (EPA) and the Department of Justice (DOJ) cooperated in federal environmental enforcement by establishing the Office of Environmental Justice (OEJ), which focuses on cases related to pollution, environmental crime, and climate change. 

Our recent paper explores the link between firms’ toxic releases and their investments in green innovation. Given that corporate green innovation helps firms address climate change and environmental concerns, our study aims to examine the extent to which high-pollution firms attempt to mitigate environmental and climate problems through green innovation. The main motivation of our research is the theoretical tension underpinning the relationship between corporate green innovation and toxic emissions. On the one hand, high-pollution firms should produce more green patents to reduce their regulatory burden and government investigations (e.g., EPA penalties). There is anecdotal evidence to suggest that firms invest in technology to address regulatory concerns. For instance, as part of their settlement with the DOJ and the EPA to resolve alleged emissions violations, Cemex agreed to invest approximately $10 million to use state-of-the-art technology to reduce harmful pollution. The consequences of environmental awareness provide additional support for this positive relationship between the level of firms’ toxic releases and green innovation since environmental awareness is likely to increase investor activism, the cost of capital, and regulatory burdens. 

On the other hand, impediments such as regulatory arbitrage and managerial short-termism could mean that the green patenting efforts of high-emission firms are indistinguishable from those of low-emission firms. Thus, a priori, we do not have a clear expectation of the relationship between toxic emissions and green patenting. 

Our empirical results show a strong positive relationship between firms’ toxic emissions and green patents. Specifically, we find that firms with high toxic emissions produce more green patents of higher quality and value than those with low toxic releases. Importantly, emissions associated with human health impacts and onsite toxic releases are the main drivers of this relationship. Our findings also indicate that high-emission firms produce green innovation directly related to environmental risk management. Furthermore, we show that high-pollution firms utilize exploitative and explorative methods to generate green patents, indicating a desire to explore costly new technologies rather than merely developing expertise. 

Two Experiments: Trump’s Election and the BP Deepwater Horizon Oil Spill 

We establish causality by considering the following two exogenous shocks: (1) the election of U.S. President Trump (on November 9, 2016) and (2) the BP Deepwater Horizon oil spill (on April 20, 2010). First, the unexpected election of Donald Trump as U.S. president in 2016 significantly reduced environment-related policy uncertainty and, with it, a potential reduction in regulatory liabilities. If firms’ green innovation is driven by the regulatory burden associated with toxic releases, then we should observe a weaker relation between toxic emissions and green patenting in the years following Trump’s election. We indeed find that firms with high levels of toxic releases, especially those headquartered in the U.S., substantially reduced their green patenting efforts following Trump’s election. In addition to establishing a causal link between firms’ toxic releases and their green patenting, our results support the argument on legal liabilities and show that local environmental and climate policy plays an important role in companies’ green innovation decisions. 

Second, we use the BP Deepwater Horizon oil spill that began on April 20, 2010, as a quasi-natural experiment to test the causal effects of firms’ toxic emissions on corporate green innovation. This unexpected incident arguably serves as an exogenous shock to the environmental awareness faced by high-emission firms in extractive industries, thereby strengthening these firms’ emphasis on and attention to green innovation. If firms’ toxic emission levels drive changes in corporate green patenting, we expect that extractive companies with higher toxic release levels at the Deepwater Horizon event would subsequently do more to improve their green credentials. Our empirical results show that the positive relationship between toxic release levels and green innovation improved significantly for firms in extractive industries in the post-event period. This finding supports the environmental awareness argument for the positive relationship between emissions and green patenting. 

Do Constraints Hinder High-Emission Firms’ Green Patenting Efforts? 

Our cross-sectional tests explore whether financial constraints and limited asset redeployability attenuate the positive relationship between firms’ toxic emissions and corporate green innovation. Financial constraints do not seem to impede high-emission firms’ green patenting. Financially constrained firms reduce their efforts related to nongreen patenting far more than those related to green patenting activities. One explanation for this result is that because financial constraints may simultaneously limit innovative activities and increase environmental abatement costs, financially constrained high-emission firms are likely to maintain their green innovation to achieve higher abatement efficiency, thereby controlling potential legal liabilities. Thus, these firms sacrifice nongreen innovation instead of green innovation. 

Moreover, we show that limited asset redeployability impedes nongreen and green patenting for high-pollution firms. However, further investigation reveals that while high-emission firms with low asset redeployability produce fewer climate change mitigation (CCM) green patents, they maintain their efforts toward environmental-related green patents. This makes sense as environmentally green technologies are essential to controlling toxic emission levels and abatement expenditures involved in daily operations. Overall, our findings imply that in the presence of financial or asset redeployability constraints, high-emission firms maintain their innovative green activities, particularly those highly relevant to their toxic emissions (i.e., environmental green innovation). 

The Implication of Green Innovation 

Finally, we explore the implications of firms’ green innovation. Based on regression estimates of changes in toxic air releases on environmental and CCM green innovation, we find that green patents, particularly environmental-related patents, help mitigate toxic air releases. This finding indicates that generating environmental patents by high-emission firms is not greenwashing but a genuine effort to control their pollution. 

Conclusion 

Environmental and climate change issues have been highlighted in recent years and affect many aspects of financial markets and corporate policies. Recent studies also provide evidence that investors and corporate managers care about environmental and climate risks. Firms’ toxic releases, a leading cause of environmental and climate problems, have become a focus of attention among governments, investors, and scholars. In our recent paper, we link firms’ toxic releases to their green innovation measured by green patents that have the potential to mitigate environmental and climate issues. Overall, we demonstrate the positive effect of firms’ toxic emissions on their green innovation and that this effect can be affected by local environmental and climate policies and environmental awareness. 

 

Wenquan Li is a Ph.D. candidate in Finance at the UQ Business School of the University of Queensland. 

Suman Neupane is a Senior Lecturer in Finance at the UQ Business School of the University of Queensland 

Kelvin Jui Keng Tan is an Associate Professor in Finance at the UQ Business School of the University of Queensland. 

This post is adapted from their paper, “Toxic Emissions and Corporate Green Innovation,” available on SSRN. 

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