Go Green Or Go Bust? The Profitability of Eco-Technology

Green innovation is often seen as the key to sustainable growth. But, not all eco-technologies deliver the same results.

Cheng Qiang from Singapore Management University examines how pollution prevention and pollution control impact firms’ profitability and environmental performance, revealing why prevention strategies offer greater financial and environmental returns.

Read the original research: doi.org/10.1016/j.jacceco.2024.101706

Transcript

Hello and welcome to ResearchPod. Thank you for listening and joining us today. 

In this episode, we look at the research of Dr Cheng Qiang, Professor in the School of Accountancy at Singapore Management University. In his most recent co-authored work, Cheng explores how green innovation affects both the profitability of firms and their environmental impact. More specifically, investments in pollution prevention and pollution control can bring distinct futures for firms. Dr. Cheng and his co-authors investigate both types of green innovation, providing valuable insights into when and how eco-friendliness can be profit friendly. 

Climate change is increasingly recognised as a profound threat to life and the way we live. Some believe that environmental technologies will facilitate the transition to a more sustainable economy. In the United States, large companies have committed billions to such innovation. In 2020, investments in decarbonization reached $500 billion globally, twice the amount as in 2010. However, discussions in the media often overlook differences between types of green technology, and scarce research examines how companies can adapt to climate change through innovation.
 

Existing research that does broach the subject finds that applying environmental technologies has mixed results for a firm’s profitability, depending on the form this takes. A case in point is Xerox. The print giant had once used a chemical pollutant in its manufacturing. The chemical was extracted later in the production process through a costly method of distillation and then disposed of. However, when the company acted to reduce their initial use of the chemical in production lines, the cost of raw materials and waste disposal was slashed, and productivity increased. This example points to the benefits of pollution prevention over pollution control, with the former aiming to reduce pollution at its source and the latter dealing with pollution after it is generated – and often at great cost.

As shown by the innovators at Xerox, pollution prevention can save firms the expense associated with pollutant clean-up. It does this by altering the methods of production or the materials used, so as to avoid unwanted contaminants in the manufacturing process. In addition to lowering production costs, pollution prevention can increase sales among consumers looking for greener products. Finally, pollution prevention technologies are often difficult for other firms to imitate, giving companies a competitive edge in their profit margins and green reputation within their respective markets. This is why, in their study, Cheng and his co-authors first predict that firms making innovations in pollution prevention will experience better financial performance. But with other factors at play, this prediction could be falsified. A boost in performance from prevention strategies relies on the pollutants in question being predominantly waste. However, some pollutants can be an unavoidable by-product of manufacturing and so cannot be removed from the process itself. In such cases, pollution prevention is unfeasible and cannot boost a firm’s profits.

Pollution control, on the other hand, generally adds a large cost for firms, without improving their profit margins or sales among environmentally conscious consumers. Indeed, the act of managing, treating, or disposing of pollutants carries a high price tag that mainly helps firms to avoid steep regulatory fees. Thus, the researchers predict that pollution control has no association with firms’ future financial performance. And finally, the researchers predicted that both forms of innovation will help to reduce environmental harms, either by controlling the contamination that was created during manufacturing process or by excluding the pollutants from the production process. To test these hypotheses, Cheng and his co-authors collated green patents from 1997 to 2017 to uncover how the two forms of green innovation affect companies financially and environmentally. 

The study firstly showed that during the time period, pollution prevention patents have rapidly increased. The gap between the two types of innovation has progressively widened.  

This indicates that firms are prioritising pollution prevention over pollution control in their business strategies. Moving to the core analysis, researchers examined the environmental impact of firms applying green technologies. To do so, they gathered data on greenhouse gas emissions reported by firms, as well as the statistics on firms’ chemical emissions published by the US Environmental Protection Agency. Findings showed that higher-value patents for prevention technologies were associated with lower levels of future pollution. Surprisingly, however, there was no association between pollution control patents and pollution levels. One explanation for this finding may be that pollution control technologies are easily transferable, allowing firms to purchase them externally rather than developing them in-house. Therefore, pollution control patents may not fully represent firms’ investments in these technologies.

Researchers also tested how the different types of green innovation impact firms' future financial performance. The study found that the value of a firm’s patents in pollution prevention is positively associated with its financial success, as indicated by higher return on assets. Furthermore, the financial reward of prevention technologies was most pronounced in energy-dependent industries, such as the production of steel, cement or chemicals, and those with higher pollution levels in the past. Meanwhile, there is no significant link between the value of pollution control patents and firms’ future financial performance.

One reason for the little impact observed from pollution control upon a firms’ financial performance could be that the benefits – which include lower regulatory costs and reduced risk of litigation - might only show up in accounting figures after some time. Indeed, these benefits are better reflected in stock prices than Return on Assets. Meanwhile, the measure of Return on Assets does not include the cost of investing in pollution prevention or control. So, to better understand the impact of green innovation on firm value, the study replaces Return on Assets with Tobin’s Q. This measure incorporates a more refined set of financial variables, and yet with this tool, researchers confirmed a significant link between pollution prevention patents and financial success, but no significant connection with pollution control.

After establishing that pollution prevention offers firms a financial boost, researchers conducted two additional analyses to sharpen the insights. First, they looked at the mechanisms through which pollution prevention could be profitable. One avenue is for firms to attract environmentally conscious customers, leading to increased sales. Another mechanism is the reduction of clean-up costs, which can improve gross margins and efficiency. Researchers found evidence to support both benefits, as the value of pollution prevention patents correlates positively with future sales growth, gross margins, and operational efficiency. 

Finally, researchers sought to investigate the factors that encourage firms to engage in environmental innovation and to adopt specific green technologies. To do this, they examined the relationship between green patents and various firm characteristics. In addition, the study took account of firms’ history of environmental compliance, their environmental violations, and public concern about climate change - as reflected by the maximum daily air temperature where the firm is located. All factors were measured one year before patent variables, to allow time for firms to start investing in green technologies as a result of those influences.

Results show that bigger firms with higher budgets for research and development, more past environmental violations, and in hotter counties tend to adopt pollution prevention innovations. Similarly, control technologies were more popular among larger firms and with previous violations, but also with older firms, whilst control patents were less common for firms in warmer regions and with more cash. Overall, these findings show that investments in pollution prevention and control technologies differ based on firm characteristics and past experiences.

This study contributes to the business and sustainability literature in two key areas. First, it deepens our understanding of the relationship between firms’ environmental innovation and future financial performance. By breaking down environmental technologies into pollution prevention and pollution control, researchers show that pollution prevention enhances both financial and environmental outcomes, unlike pollution control. This demonstrates that the choice of method is key for deriving business benefits from ‘going green’. Meanwhile, Cheng and his co-authors have established a methodology that may prove useful for future research. Indeed, their approach could provide a foundation for building new insights into how green innovation impacts firms. 

That’s all for this episode – thanks for listening. Be sure to check out Dr Cheng Qiang’s original research, linked to in the show notes for this episode. And, as ever, be sure to stay subscribed to ResearchPod for more of the latest science!

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