Racing to the bottom and racing to the top: The crucial role of firm characteristics in foreign direct investment choices

This study builds on the pollution haven and induced innovation arguments as explanations for firm behavior with regard to international environmental management and argues both need to be integrated. This implies that foreign direct investment is capable of facilitating a “race to the bottom” and a “race to the top” simultaneously. Using novel and detailed data, we test whether environmental capabilities and weaknesses and other characteristics affect US firms’ foreign direct investment choices in Chinese provinces with more or less stringent environmental regulation. This enables a more detailed analysis by allowing country regulation to vary spatially and over time. Our study finds that heterogeneity in capabilities and firm size jointly determine foreign direct investment and in doing so shows the simultaneity of a race to the bottom and to the top. Specifically, firms with environmental capabilities invest in more stringently regulated regions and firms with weaknesses are less likely to target such regions. These diverging effects are both moderated by firm size, which further amplifies each of them. Our findings underscore the need to integrate pollution haven and induced innovation arguments in a joint analysis. They furthermore show the relevance of methodological choices when testing hypotheses integrating the above arguments empirically.