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Does the Porter Hypothesis Explain Expected Future Financial Performance? The Effect of Clean Water Regulation on Chemical Manufacturing Firms

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Abstract

Previous research provides opposing theoretical arguments regarding the effect of environmental regulation on financial performance. As one important argument, the Porter hypothesis claims that tighter regulation improves financial performance. This study provides empirical evidence on this debated effect. In particular, we employ panel data analysis to examine the effect of Clean Water Act regulation, as measured by permitted wastewater discharge limits, on expected future financial performance, as measured by Tobin’s q, for publicly owned firms in the chemical manufacturing industries. We find that tighter permitted discharge limits lower Tobin’s q; i.e., more stringent Clean Water Act regulation undermines expected future financial performance. By decomposing Tobin’s q into its constituent components—market value and replacement costs—and estimating each component separately, we find that tighter permitted discharge limits lower both components with a larger impact on market value, which implies that investors revise their expectations of the discounted present value of future profits in response to changes in Clean Water Act regulation.

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Correspondence to Dylan G. Rassier.

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The views expressed in this manuscript are solely those of the authors and not necessarily those of PricewaterhouseCoopers. This manuscript was developed under a STAR Research Assistance Agreement No. R-82882801-0 awarded by the US Environmental Protection Agency. It has not been formally reviewed by the EPA. The EPA does not endorse any products or commercial services mentioned in this manuscript.

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Rassier, D.G., Earnhart, D. Does the Porter Hypothesis Explain Expected Future Financial Performance? The Effect of Clean Water Regulation on Chemical Manufacturing Firms. Environ Resource Econ 45, 353–377 (2010). https://doi.org/10.1007/s10640-009-9318-0

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  • DOI: https://doi.org/10.1007/s10640-009-9318-0

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