In this section, we introduce the core variable of our study, Pollution Prevention Activities (PPAs); discuss the characteristics of various types of PPAs and their implications; and develop hypotheses concerning the environmental and financial returns to the corporate environmental practices (PPAs).
3.1. Toxic Release Inventory (TRI) and Pollution Prevention Activities (PPAs)
The Toxic Release Inventory (TRI) is a publicly accessible database provided by the United States Environmental Protection Agency (EPA), which contains detailed information on the disposal and releases of more than 760 toxic chemicals by more than 21,000 U.S. industrial facilities [35
]. Facilities are mandated to report to the TRI if they have at least ten full-time employees and produce or use more than a designated amount of TRI-identified toxic chemicals. With the passage of the Pollution Prevention Act of 1990, the EPA began to require companies to report descriptive information about the various pollution prevention activities (PPAs) they undertook to reduce toxic releases in order to share information about good environmental practices.
Pollution prevention activities
(PPAs) refer to corporate practices that reduce or eliminate the generation of pollutants through increased efficiency in the use of raw materials, energy, water, or other resources or the protection of natural resources by conservation [35
]. Residual pollution that cannot be prevented or reduced is to be recycled or treated in an environmentally safe manner, but such post-processing activities, often referred to as end-of-pipe treatments, do not fall into the EPA’s PPA categories. In 2018, 1270 out of more than 21,000 industrial facilities (6% of all facilities in TRI) reportedly undertook 3120 pollution prevention activities. In the chemical industry, which is the focus of our analysis, a total of 737 out of 3454 chemical facilities (21.4% of all chemical plants) reported 2803 pollution prevention activities in the same year [36
]. Among the eight PPA categories identified by the EPA (Figure 1
) and discussed below, the most common are good operating practices, process modifications, and spill and leak prevention. In addition, the most common sources of PPAs are reported to be internal team management, employee engagement, and internal audits, which supposedly would not require substantial investments.
Good operating practices accounted for more than 35% of all pollution prevention activities reported in 2018, comprising such activities as increasing the frequency of planned maintenance, continuously adjusting the batch schedule to minimize changes in product quality, and reducing operator-controlled scrap through hands-on technical training. LINDE LLC, for instance, reported that more frequent planned maintenance of packing and gasket materials resulted in decreased emissions and raw material use. The second most common type of PPA was process modifications, including modifying production processes to reduce the use of toxic materials, such as solvents, using solvents for an additional cycle before disposal, installing a printing press that recovers solvents more efficiently, optimizing chemical reaction conditions, and replacing toxic materials with non-toxic ones. An example of spill and leak prevention, the third major type of PPA, was BASF Corporation’s implementing of a new employee-recommended policy that reduced spills by electronically identifying all hoses used to transfer chemicals and testing them annually.
The PPAs also included raw material modifications, exemplified by a new process adopted by RENCO Group that largely eliminated the use of a high xylene-content material through the use of flame and plasma surface treatments and better formulations of water-based painting technology. An example of another PPA type, inventory control, was Honeywell’s just-in-time inventory system, which reduced the use of lead by 22% via minimizing raw material storage and potential waste streams from expired or out-of-specification products. Surface preparation and finishing refers to such activities as modifying spray systems or equipment, substituting coating materials, and improving application techniques. Cleaning and degreasing refers to such practices as improving rinse equipment design and operation, replacing solvents or other materials with mechanical stripping/cleaning devices, modifying containment procedures for cleaning units, and improving draining procedures. Unlike the abovementioned process-related activities, product modifications is a demand-oriented PPA, such as Superior Brass and Aluminum Casting’s work with customers to replace its previous alloy containing a maximum of 6% lead with a new alloy containing a maximum of 0.09% lead. Product modifications also encompass the restructuring of existing businesses or product portfolios, such as a disinfectant producer who switched from using a 2-phenylphenol–based cleaning product to developing alternative products free of the chemical.
The eight types of PPA can be broadly grouped into production- and demand-side activities, with the production-side activities accounting for approximately 94% of the total reported number of PPAs (Figure 2
). Although product modifications as a general category would have a more pronounced impact on firms’ sales and market positions than other activities, product modifications that lead to pollution prevention accounted for a relatively minor fraction (6%) of the reported PPAs. In sum, the chemical firms’ activities to improve their environmental performance mainly concerned improvements in production processes, from incremental efforts to reduce material inputs and lead time to relatively challenging activities such as modifying processes, the latter of which may involve a departure from their conventional production and operating practices. Compared to conventional environmental management activities focusing on posterior waste treatments, these PPAs are likely to have a more direct influence on firms’ cost structures and value chains. They can also have a favorable impact on a business’s bottom line because they typically do not require a large financial investment or radical organizational changes but rather relatively incremental improvements made in the spirit of Total Quality Management (TQM).
Three sets of hypotheses were developed to test the relationship between our major constructs in a systematic manner, which is shown in Figure 3
. The first of these sets (H1) concerns the direct effects of the PPAs on the firms’ financial performance in light of cost competitiveness and market value, which is the main focus of our study. The second set of hypotheses (H2) posits the relationship between PPAs and environmental performance, in particular whether and to what extent various PPAs undertaken by individual plants contribute to their environmental performance and how the association might vary with the type of business. The third set of hypotheses (H3) addresses the association between the parent firms’ environmental performance and their financial performance.
Prior literature suggests that the use of pollution prevention technologies or practices increases the efficiency of production [37
] via better utilization of inputs, savings from recycling or reusing materials, and reduction of waste disposal costs [22
], and reduces production lead time by enabling the simplification or removal of unnecessary operational steps and the adoption of higher-quality monitoring equipment [21
]. These pollution prevention activities, which in many cases involve relatively modest investments and organizational changes, would have the potential to improve profitability. Porter and Linde [21
], for instance, argue that stringent environmental regulations can inspire innovations that help organizations minimize costs and ultimately become more competitive in the market. This counter-intuitive finding that preventive environmental actions or investments can actually provide a competitive advantage can be better understood by adding the dimension of “competing for the future” [19
] to a resource-based view of the firm. Hart [19
] proposes a natural-resource view of the firm, arguing that, by employing pollution prevention
measures as one among the three types of natural environmental strategies, companies can realize significant savings, resulting in a cost advantage.
Considering the complete set of PPAs in our study, however, the ways and degrees to which specific PPA types might affect a firm’s production costs seem less clear. This is particularly true for those PPAs that might present more pronounced trade-offs rather than synergies between environmental and economic performances. Good operating practices, for instance, would clearly endow companies with increased resource management efficiency by lowering requirements for raw material use without incurring much, if any, additional cost. The potential impact of financial returns to process modifications, however, may seem more ambiguous, as the activities would involve additional capital expenditures and other costs associated with employee training and temporary quality compromises, especially when the firm has already optimized its production processes. PPAs categorized as raw material modifications would also require substantial added costs, as hazardous materials are often replaced by more environmentally friendly but expensive ones, although inventing new treatment technologies or discovering better formulations may prove less expensive. Similarly, spill and leak prevention activities, which do little to reduce material inputs, may require supplementary investments to improve monitoring capabilities. Product modifications, which involve restructuring in production processes and businesses, are not likely to result in an immediate improvement in financial performance, either.
Nonetheless, our examination of the U.S. chemical sector indicates that the PPAs conducted by the chemical plants involve mainly activities associated with reductions in material input or production lead time and process modification rather than product modifications or spill and leak prevention (Figure 2
). As a result, the PPAs are expected to directly reduce the material costs that account for the largest share of the cost structure of the chemical industry and possibly also reduce other costs of production due to the improvement of process efficiency, contributing to profitability. Given that implementing such process-related PPAs may result in non-trivial improvements in resource use efficiency and process innovations without necessitating large additional investments, the programs are likely to pay off and strengthen firms’ cost competitiveness in spite of the mixed financial implications of the diverse PPAs addressed above.
We therefore hypothesize that the PPAs in the chemical sector will have a positive influence on production costs and consequently on gross profits, with the effect being prominent enough to enhance the cost competitiveness of firms undertaking the PPAs and possibly their market valuation as well. Although the effect of a firm’s PPAs on market valuation is less straightforward than their effect on cost competitiveness, we do not dismiss the reasonable likelihood that more intensively undertaking PPAs may lead to higher profit streams and thus higher financial market valuations for firms through the cost competitiveness channel or through the development of inimitable organizational resources as a source of competitive advantage on a longer-term basis. According to Feldman et al. [38
], “investment in environmental management leads to substantial reduction in perceived risk of a firm” which, if all else is equal, would drive up the firm’s stock price. A number of studies have also hinted at ways in which disclosure of environmental information in news reports might affect market valuation. For example, Konar and Cohen [39
] found that negative media attention as a “pollution company” via the public disclosure of TRI data had a negative effect on firms’ stock price, and Klassen and McLaughlin [13
] conducted an event study analysis to see whether the arrival of news on high toxic emissions or environmental performance awards resulted in significantly negative or positive abnormal returns to the listed firms.
Although few examine the effects of environmental practices on market value, an exception is King and Lenox [34
]. Estimating the amount of emission reductions achieved by prevention, treatment, and transfer chemical waste management activates, they found that only waste prevention was associated with market valuation as expressed by Tobin’s q. Our hypotheses thus explicitly consider the mechanisms by which environmental management activities can improve financial performance in terms of cost competitiveness and market valuation, respectively:
The more intensive a firm’s pollution prevention activities, the greater its manufacturing cost competitiveness due to the associated improvement of production process and resource-use efficiency.
The more intensive a firm’s pollution prevention activities, the greater its financial market valuation due to improved profit prospects.
To further establish the triadic linkage between environmental practices, environmental performance, and financial performance, the study next tests whether chosen PPAs do indeed improve environmental performance and, if so, how the relationship between them might be explained. Surprisingly few studies have empirically tested the relationship between environmental managerial activities and performance. Although one might easily presuppose a strictly positive association between environmental actions and outcomes, this may not be the case, as PPAs, particularly those installed under strict environmental regulations, can be used as a means to increase the level of output, offsetting any environmental improvement achieved by the PPAs. We thus assert that this relationship needs to be empirically tested at the level at which the action takes place and bears fruit; the ties between the two can be reliably identified without introducing other confounding factors only when environmental outcomes are measured as closely as possible to where those environmental actions are mainly undertaken. This perspective is also consistent with a resource-based view of firms, which suggests that “the type of environmental technology implemented would be linked directly to the presence of specific strategic resources, possibly at the plant level”, and that because “the strength, value, and competitive advantage of continuous improvement varies between plants within the same firm, the use of pollution prevention technology is also likely to vary” (see p. 601 of [14
]). Our study draws on the plant-level data provided by the TRI to test this relationship.
We also suggest that business-specific circumstances need to be explicitly taken into account in establishing the link between corporate environmental activities and environmental performance. Earlier studies have noticed the role of organizational assets or antecedents that influence organizations’ environmental strategies, including managerial commitment and the type of industry [40
], learning effects [42
], and ownership structure [41
]. Unlike previous multiple industry studies conducted at the more aggregate three-digit NAICS level (standard industry code), we instead limit our analysis to a range of chemical industry subsectors at the four-digit NAICS level in our attempt to tease out the potential interaction effect of business type and environmental strategy on environmental performance. Our conjecture is that business types can moderate the impact of chosen PPAs on environmental performance to a degree depending upon the inherent pollution intensity of the business and its cost profiles. In other words, the degree to which individual PPAs chosen by plant managers contribute to their environmental performance would vary across business subsectors within the chemical industry, which comprises widely varying products, cost structures, pollution intensities, and available pollution abatement options. Our plant-level hypotheses are as follows:
A plant’s pollution prevention activities will positively affect its environmental performance.
The more pollution- and manufacturing cost-intensive the business category to which a plant belongs, the greater the effect the PPAs will have on its environmental performance.
Lastly, our study examines the relationship between environmental performance and financial performance at the firm level in terms of cost competitiveness and market valuation. Although a resource-based view of the firm may provide a theoretical entry point to that relationship by highlighting the connection between firms’ proactive environmental managerial capability and their financial performance [20
], we note that higher environmental managerial capability or prudent environmental practices that provide competitive advantages may not necessarily be conditioned on higher environmental performance. Thus, legitimacy theory and stakeholder theory may provide more plausible explanations of the process by which superior environmental performance may lead to improved market performances in terms of stock market valuation. According to legitimacy theory, a systems-oriented view of the organization and society within which firms are influenced by, and in turn have influence upon, the society in which they operate [43
], a firm’s survival can be threatened if society perceives that the firm has breached its social contract [44
], while stakeholder theory asserts that information can be employed by a firm to gain the support and approval of its stakeholders or to deflect their opposition and disapproval. Together, these theoretical frameworks suggest that firms with superior environmental performance are likely to incur lower direct and indirect costs from environmental regulations or lawsuits and to achieve more favorable contract terms and relationships with their supply-chain partners, eventually leading to higher market valuation. This premise is supported by a few empirical studies that suggest that investors may perceive a firm’s poor environmental performance as a potential cost or liability and respond accordingly [12
], resulting in a decreased market value.
We test firm-level hypotheses regarding the positive relationship between environmental and financial performance to complete the triadic linkage between environmental practices, environmental performance, and financial performance, while at the same time maintaining logical consistency with the above two sets of hypotheses. Our firm-level hypotheses are given as follows:
The higher a firm’s environmental performance, the higher its manufacturing cost competitiveness.
The higher a firm’s environmental performance, the higher its market value.