Theory and Methodology
An empirical evaluation of environmental efficiencies and firm performance: Pollution prevention versus end-of-pipe practice☆

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Abstract

Environmental advocates maintain that waste minimization, recycling, remanufacturing and other environmental practices will greatly enhance the “bottom-line” for organizations. We investigate the differential relationships between (separately) pollution prevention and end-of-pipe efficiencies with short-run financial performance (measured using return on sales (ROS)). After controlling for both firm size and financial leverage, we find that for 482 US firms in 1992, pollution prevention and end-of-pipe efficiencies are both negatively related to ROS, and that this negative relationship is larger and more significant for pollution prevention efficiencies.

Introduction

There is an on-going debate regarding the relationship between corporate environmental performance and financial performance. The research findings, thus far, have been contradictory (Cordeiro and Sarkis, 1997), suggesting the need to institute finer-grained performance measures and to recognize and control for multiple contingencies that may impact the relationship between environmental and financial performance.

In the present research, we revisit this relationship between environmental and financial performance at the firm level, using a comparison between the differential effects of pollution prevention efficiencies and end-of-pipe treatment approaches. We use a two-stage analysis. First, the technique known as data envelopment analysis (DEA) is used to evaluate environmental “efficiencies”. Next, these efficiencies are related to the firm's financial performance. The data for calculation of efficiency scores are derived in part from the US Environmental Protection Agency's (EPA) toxic releases inventory (TRI) database. The literature in this area along with cooperative regulatory measures suggests that pollution prevention, specifically waste and source reduction, is more proactive, and may prove more effective than end-of-pipe solutions such as external recycling, treatment and recovery2, in terms of long-term environmental performance (Hart, 1997; Porter and van der Linde, 1994). However, the impact on short-term financial performance has not been investigated. Our research is one of the first empirical evaluations of these relationships.

We begin by reviewing the growing body of literature on the relationship between corporate environmental performance and financial performance, the differential impact of pollution prevention and end-of-pipe approaches, and develop the study's hypotheses. We then proceed to a brief review of the data and the data envelopment analysis (DEA) models used for calculation of the efficiency scores. We conclude with a presentation of our research findings, a discussion of the results obtained and a brief agenda for future research.

Section snippets

The recent turn to corporate environmental proactivism

Historically, corporate environmental policies were designed primarily to meet regulatory requirements and to appease communities, largely as a reactive effort. In the past decade, however, environmental proactivism by corporations has increased due in part to the impact of: (1) ever-increasing regulatory expenses; (2) stringent disclosure requirements to shareholders, lenders, and the public; (3) escalating civil and criminal penalties; and (4) the increasing cost and scope of environmental

Data and methodology

In this section, we detail the data sets and the methodology for investigation. The methodology is based on a two-stage approach of (1) calculating DEA efficiency scores and (2) using these efficiency scores as dependent variables for a multiple regression model that incorporates firm characteristics and performance. This two-stage (i.e. DEA scores used in subsequent regression analysis) approach is quite common and is considered a methodologically sound approach by a number of researchers. The

Environmental variables and operationalizations

The primary data parameters used for environmental performance are from the EPA's TRI database. The TRI data are compiled from reports submitted by U.S. domestic corporations under section 313 of the Emergency Planning and Community Right-to-Know Act (EPCRA, or Title III of the Superfund Amendments and Reauthorization Act of 1986), Public Law 99–499. Organizations are required to provide information to the public and to aid the EPA in determining the need for future regulations. The reporting

The DEA models

DEA is a multifactor productivity analysis model that has been gaining much popularity among researchers as well as practitioners. The technique provides a non-parametric analysis of multiple inputs and outputs for a “decision making unit” (DMU). Its goal is to calculate a weighted multifactor productivity (efficiency) score for a unit of analysis (typically defined as a decision making unit (DMU)). The efficiency scores are determined by a relative evaluation of one DMU with respect to all

Financial measures

In the second stage of our analysis, we used a multiple regression analysis (using ordinary least squares) to investigate the impact of environmental efficiency on short-term financial performance, after controlling for firm size and leverage. The TRI data were merged with firm financial data from the SEC Disclosure database for 1993. The firm performance variable used was return on sales (ROS). This variable is obtained by taking the firm's net income and dividing it by firm size. A version of

Results and discussion

Table 2 provides the descriptive statistics for the variables used in this study. The final sample of 482 firms was used in all subsequent analyses. The industries covered ranged from SIC 2000–3999.

The multiple regression models, estimated using ordinary least squares are

Firm short-run financial performance = f (Environmental efficiency; firm size; firm leverage; error)

As was noted earlier, we used separate models: (a) end of pipe, and (b) pollution prevention measures of environmental

Conclusions and future research

The work presented in this paper is one of the first to look at possible performance differences between pollution prevention and end-of-pipe environmental management policies of organizations. We found that overall there is a negative correlation between environmental performance (based on DEA calculated efficiency scores of TRI data) and short-term corporate financial performance (based on ROS). We also found that pollution prevention results had a larger negative relationship than

Acknowledgements

Special thanks to Richard Puchalsky of The Unison Institute for help in accessing and summarizing the TRI database.

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    The editorial review process for this article was handled by Professor W.C. Benton.

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