The Role of Innovation on the Link Between Environmental Regulations and Firm Performance: A DEA Approach

The nature of impact of regulatory policies on improving firm performance is a hotly debated topic based on the Porter’s hypothesis. Even more debated is the role of innovation in this link. The literature has several studies that suggested a positive role of innovation while there are equal number of studies that suggested a negative and even a neutral role. In this paper, we provide a new look at this topic using data envelopment analysis (DEA). Unlike previous studies that looked at the relationships primarily using statistical principles, we first study the link between regulatory pressures on firms and their performance using DEA using the software MaxDEA. We then study the impact of innovation using both Tobit and normal OLS regressions. We use data from 36 different Chinese industries over a five-year time period, totaling to a sample size of 180. In line with previous studies, the intensity of environmental regulations is captured in our study using the level of industrial emissions. Financial performance is captured using three measures – profits, interest expenses and total assets. Innovation is captured using R&D expenditure. Our study has supported a weak influence of innovation on the link between regulatory pressures and firm performance. In this sense, this paper joins previous studies that found a weak positive or neutral link on the influence of innovation on the regulation-performance link. We provide reasons for this conclusion and highlight suggestions for future research in this direction.