Beyond Profit: Revealing the Nexus Between Corporate Environmental Responsibility and Innovation in Eastern European SMEs

This research aims to examine the effect of corporate environmental responsibility (CER) on innovation and firm performance by using pooled cross‐sectional data on a sample of 10,410 observations of Eastern European small and medium‐sized enterprises (SMEs) over the period of 2018–2020. We constructed an appropriate proxy index of CER using principal component analysis (PCA) which revealed that CER is based on three pillars: (i) energy monitoring and efficiency, (ii) greenhouse gas emissions, and (iii) pollutants' emissions. To address reverse causality and endogeneity biases, we employed two‐stage least squares (2SLS) analyses and instrumental probit (IVProbit) regression. Results show that CER positively influences research and development expenditures, external knowledge acquisition, and product and process innovation. In contrast, CER negatively affects firm performance. In addition, the findings prove that corporate innovation has a mediating role between environmental responsibility and firm performance. These results imply that investing in environmental responsibility can improve innovation and competitiveness of Eastern European SMEs. Yet, managers also need to be aware of the potential detrimental consequences on short‐term firm performance. Overall, the results suggest that firms in Eastern Europe may face trade‐offs between environmental responsibility and financial performance. While environmental responsibility may lead to increased innovation, it may also have negative effects on firm performance. Accordingly, firms have to carefully take into consideration the costs and benefits of implementing environmental practices and seek ways to balance their environmental and financial goals. The development of more effective environmental regulations and support mechanisms tailored to SMEs by governments and policymakers can neutralize this negative effect.