Pollution havens versus gates of hell: Environmental pollution and multinationals' foreign investment

Research Summary This study investigates an under‐explored cost of operating in pollution havens: the pollution‐induced operational cost, or the increased labor costs and material supply constraints resulting from host countries' environmental pollution. Environmental degradation can thus turn “pollution havens,” where lax compliance beckons institutional arbitrage and attracts investments from foreign firms, into “gates of hell,” where ecological damage heightens the costs for business operations and discourages foreign investments. We find evidence in a panel of US multinational corporations from 2007 to 2020. A firm's investment in a host country is decreasing in the host country's environmental pollution, especially if the firm faces heightened constraints in finding alternative labor inputs and material supplies or is highly dependent on these resources. Managerial Summary Our findings offer practical insights for multinational corporate managers and policymakers. First, managers need to evaluate the opportunity of arbitrage against the cost of operation associated with environmental pollution, especially considering their firm's labor and material supply constraints. Second, policymakers should consider the price of relaxing environmental regulations to attract foreign investments. While weak environmental policies may spur investment from arbitraging firms into a (developing) country, unregulated destruction of the natural environment will inflict inevitable operational costs to destroy broader business opportunities, as the crucial resources (e.g., labor inputs and material supplies) become degraded by pollution.