How Does Environmental Policy Stringency Affect Inefficiency of Firms? New Evidence from International Firm-level Data

This paper examines the strong version of the Porter hypothesis (PH) using a huge international firm-level dataset of approximately 800,000 observations during 2010–2015. To examine the impacts of the environmental policy stringency (EPS) on firms’ inefficiency, this paper applies the technical inefficiency effects model of stochastic frontier analysis to examine the nonlinear impacts from the total EPS index and four policy instruments of standards, tax, trading schemes, and research and development subsidies. To address potential endogeneity, predicted EPS indices are employed in the estimation. Empirical results indicate that the strong PH holds for both the aggregate total and all individual environmental policy instruments when EPS exceeds the threshold. The estimated results by policies and industries are qualitatively nearly the same. Empirical findings validate that the strong PH holds when environmental regulations are tightened beyond a certain level. Finally, the "appropriate mix of instruments” instead of “best instrument” is recommended by this paper.