Are More Innovative Firms Less Vulnerable to New ... - Springer Link

Environmental & Resource Economics (2007) 36:295–311 DOI 10.1007/s10640-006-9023-1

Springer 2006

Are More Innovative Firms Less Vulnerable to New Environmental Regulation?q JOAQUIŃ CANÕŃ-DE-FRANCIA*, CONCEPCIOŃ GARCE´S-AYERBE and MARISA RAMI´REZ-ALESOŃ Department of Economics and Business Management, Facultad de CC. EE y EE., University of Zaragoza, Gran Vıá, 2, 50005, Zaragoza, Spain; *Author for correspondence (e-mail: [email protected]) Accepted 2 August 2006 Abstract. Compliance with pollution limits and standards requires firms to implement adaptation processes that are not only costly themselves but also affect future profits in as much as they modify production systems and methods. This paper attempts to respond to the question of how technological knowledge moderates the effect that the implementation of a new environmental regulation has on the results of affected firms. The regulation selected for this study is the Integrated Pollution Prevention and Control Act (IPPC). A Multivariate Regression Model (MVRM) has been applied to the regulatory event. The most important implication of this paper is that technological knowledge prepares a firm for adapting to a greater environmental demand such as may be derived from a new regulation. Key words: environmental regulation, market value, technological knowledge

1. Introduction Environmental regulation is the most effective mechanism enabling firms to internalise the effects of their production activity on the natural environment. However, compliance with pollution limits and standards requires firms to implement adaptation processes that are not only costly themselves but also affect future profits in as much as they modify production systems and methods. Therefore, since the 70s when the process of environmental regulation of industry began, many studies have analysed the repercussion of this process on the financial results of firms. The first studies to appear, which were based on US regulations, concluded that investments made by industry to comply with environmental standards decreased growth of productivity and the competitive capacity of firms (Jaffe et al. 1995). Other authors have analysed q

This paper has been developed under the objectives of the CREVALOR Research Group (DGA-Spain). Moreover, it has been financed by the MEC-FEDER Research Project SEJ2005-07341.

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the repercussion of environmental regulations on the market value of affected firms. They conclude that announcements of the implementation of a new, stricter environmental regulation causes abnormally negative returns in the share price of affected firms due to future adaptation costs (Blacconiere and Northcut 1997; Freedman and Stagliano 1991; Little et al. 1995; Shane 1995). These studies have been limited to presenting the effect that environmental regulations have on business results, either through accounting, market or other measures. Nevertheless, and in spite of the fact that the main requirements of a new environmental regulation are technological, we have not found previous research studies taking into account the extent to which the prior possession of certain resources related to technological knowledge and innovation facilitates adaptation by a firm. This paper aims to examine this question, presenting empirical evidence arguing that the previous possession of technological knowledge moderates the vulnerability of companies when faced with the requirements of new environmental regulations. Our objective is to determine whether companies with greater technological knowledge suffered a smaller loss in economic value as a consequence of the publication of the implementation, in Spain, of the new environmental regulation on Integrated Pollution Prevention and Control (the IPPC Act). 2. Innovation and the Environmental Adaptation of Firms The Resource-Based View considers organisations to be dynamic and evolving concerns which respond to external pressures according to their resources and capabilities (Barney 1991; Collins 1991; Hamel 1991; Prahalad and Hamel 1990). In this regard, the conclusion has been reached that knowledge-based resources, and specifically those resources related to technological change and the capacity to innovate, are the main driving forces behind a firm’s competitive advantage (Barney 1991; Porter 1985; Zahra et al. 2000), and they are better designed to adapt to a highly uncertain environment (Miller and Shamsie 1996). Therefore, if these technological resources are available to a firm, it will be in a better position to adapt to changes in general and to changes related to protection of the natural environment in particular. Florida (1996) and Aragoń-Correa (1998), studied some of the determinants of companies’ attitudes towards the natural environment. They observed that a more innovative previous strategic orientation influenced the degree of proactivity with which a firm faced environmental problems. In this same regard, Nakamura et al. (2001), King and Lenox (2000), or Arora and Cason (1996) observed that Research and Development (R&D) favoured the development of environmental strategies, as well as the participation of a firm in voluntary policies of environmental self-regulation. The conclusions of

ARE MORE INNOVATIVE FIRMS LESS VULNERABLE

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these authors suggest that the more innovative firms involved in a process of change and continuous development and with generally high technological knowledge, are more likely to take into account environmental considerations when making decisions. A possible explanation for this result may be found in the greater ease with which these companies can adapt to the requirements of environmental protection measures. Authors such as Leonard (1984) or Sańchez (1997), for example, established that firms that are more intensive in R&D have a greater probability of responding to new environmental requirements in efficient conditions. Indeed, R&D represents a supplementary asset that facilitates firm adaptation by reducing the costs of accommodating it to new environmental requirements (King and Lenox 2000; Nakamura et al. 2001). Moreover, the economies of scale presented by R&D activities enable additional profits to be earned from R&D investment in environmental matters. Additionally, firms that are more intensive in terms of R&D could eventually influence the technological standards imposed by the regulation and thus obtain an advantage with respect to their competitors (Arora and Cason 1996). In sum, when new environmental requirements are introduced, the companies that already have sufficient technological knowledge can take advantage of the complementarities in the process of adaptation and adapt to the new requirements in a more efficient manner. They consequently improve their competitive standing. In contrast, companies facing new environmental regulations in conditions of insufficient technological knowledge will have greater difficulties in adapting to them; this could result in an inefficient response and worse performance (diseconomies). The above arguments are represented in Figure 1. Based on these antecedents, the aim of this study is to empirically determine whether there are differences between the firms that can respond to the new regulations of the IPPC Act in conditions of sufficient technological knowledge and firms that cannot. The study will thus help to solve the question of whether more innovative firms are less vulnerable to the demands of new environmental regulations. 3. Design of the Research, Sample and Methodology 3.1.

DESIGN OF THE RESEARCH

In order to achieve the study objective, we will be considering the latest environmental law passed in Spain – Act 16/2002, of 1 July, on Integrated Pollution Prevention and Control (IPPC). This law transposes Directive 96/ 61/EC of the same name to the Spanish legal system, and its objective is ‘‘to prevent or, when this may not be possible, reduce and control pollution as a whole using prevention and control systems that prevent transfer from one

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NEW ENVIRONMENTAL REQUIREMENTS Sufficient technological knowledge

Complementarities (Lower adaptation cost Technological abilities)

Efficient response

COMPETITIVE ADVANTAGE

FIRM Technological investment Insufficient technological knowledge

Inefficient response

Diseconomies

Figure 1. Technological knowledge and adaptation to new environmental requirements.

means to another.’’ The approval of this directive responded to the need to make pollution control expenditures and environmental results of industry more uniform in the various member states, where there was considerable disequilibrium (Barton 1999; Ganzleben 2002; O’Malley, 1999). Until the implementation of the IPPC, European legislation, and Spanish legislation in particular, was characterised by its geographical and sectoral dispersion (local and national regulations). These regulations established control of emissions depending on the environmental medium affected (water, atmosphere or soil). This sometimes favoured the transferring of pollution from a medium with more restrictive legislation to a medium with less demanding emission limits. The IPPC Act combined all previous regulations, adopting an integrated focus on environmental protection. The IPPC Act compels affected industrial facilities1 to make in-depth technological adaptations in order to obtain Integrated Environmental Authorisation before 2007. This authorisation specifically establishes the operating conditions that must be met by each facility regarding the environment (waste treatment, efficient use of energy, etc.), as well as the pollutant emission values that cannot be exceeded. When establishing the individual emission limits for each facility, the responsible public authorities use the Best Available Techniques2 in each sector as the reference. These techniques are the most efficient ones in environmental protection that can be applied in the industrial facility under economically and technically viable conditions. Obtaining an Integrated Environmental Authorisation is the result


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of an open and dynamic process between firms, regulators and other groups of stakeholders such as environmentalist groups (Silvo et al. 2002). Therefore, in spite of the fact that the IPPC law uses a command-and-control approach to reduce industrial emissions, it clearly involves some elements of flexibility that aim to facilitate the adaptation process of the firms affected, encouraging them to implement efficient forms of adaptation from both an environmental and economic perspective. In the presentation of the IPPC law it was made clear that integrated, preventive pollution control was a central concern. The fact that the law considers all environmental considerations as a whole means that greater priority is given to the redesigning of the production process than to the mere correction of its consequences – the scope of the law goes well beyond the previous, ‘‘end-of pipe’’ solutions (O‘Malley 1999). It attempts to reduce pollution at source, guaranteeing firms the flexibility necessary for the utilisation of the best available techniques for each process of production. It is worth noting that the IPPC law does not prescribe a single technology but uses an approach, case by case, that allows for an exchange of information, skills and knowledge between the firm and the regulator. It is this cooperation3 and the fact that it is the firm itself that ultimately decides how to achieve the emission limit values that makes the law flexible and allows for the possibility of cost-effective compliance. In other words, it seeks a balance between legal imposition and self-regulation in order to achieve an effective operational and environmental result (Silvo et al. 2002). After identifying the environmental regulation, the first step in the research consisted of analysing the long-term effect that the IPPC Act had on business results. We use Event Study, a methodology that has been used extensively for analysing the effect of regulatory changes on capital markets (Blacconiere and Northcut 1997; Lamdin 2001; Shane 1995). The Event Study requires the definition and selection of an event or events related to this law that may be significant in the process whereby investors form expectations. As Lamdin (2001) indicates, in cases of regulatory changes, generally there are various events: initially a law is proposed, then it is subsequently debated, and finally it is approved or rejected. In this study, a search has been made for announcements relating to the IPPC Act published in the main Spanish newspapers and contained in the Baratz information base for the years 2001 and 2002. Table I presents the three announcements or selected events that best reflect the procedural process of the Law. Therefore, the period of the legislative process starts with the announcement of the Law being introduced into congress for debate in February 2002 and ends with its final approval in June of 2002. Event study methodology enables us to estimate possible abnormal returns in the market value of firms as a result of the considered events. After this estimation, the next step in the research consists of a regression analysis,

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Table I. Presentation of events Event

Event content

Date

Event 1a

Start of debate on the IPPC Act in congress and publication of the estimate of compliance costs Approval of the IPPC bill by the Environmental Commission of congress Definitive approval by congress of the IPPC Act

02/07/2002

Event 2 Event 3

04/17/2002 06/14/2002

a

Corresponds to the first news published in the media on the legislative process.

which attempts to verify the possible existence of a relationship between the magnitude of the abnormal returns and the innovative capacity of a firm. This possibility is especially likely when adapting to a law such as the IPPC, which attempts to give firms flexibility as they implement it. 3.2.

DESIGN OF THE SAMPLE

The objective and methodology of this study is only applicable to firms listed on the stock exchange.4 Our sample population consists of firms that are traded on the continuous market of the Madrid Stock Exchange (127 firms) and which are affected by the IPPC Act (70 firms). In the initial phase, we based our research on these 70 firms. However, in order to screen the information, a search was made using the Baratz base of contemporary news that could alter the effect of the legislation on the share price of the respective firm. In this process, 12 firms were eliminated, which were affected on the event dates by aspects such as a drop in profits or the distribution of dividends, among other reasons. Therefore, the final sample consists of 58 firms.5 Subsequently, the daily share value was collected for each firm of the sample during the period encompassed between 24 April 2001 and 12 July 2002, which means a total of 307 shares per firm. The value of the General Index of the Madrid Stock Exchange was also collected for all the days covered by this period. In both cases, the information was obtained from the Madrid Stock Exchange. 3.3.

PRESENTATION OF VARIABLES AND METHODOLOGY

3.3.1. Cumulative abnormal return The dependent variable corresponds to the cumulative abnormal return for each firm i (CARi), derived from the joint event implementation of the IPPC Act. In order to calculate this variable, we used the Multivariate Regression

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Model (MVRM) that was first used by Gibbons (1980), followed by Schipper and Thompson (1983), Collins and Dent (1984), and Binder (1985a, b, 1998). The MVRM is used because, when a legislative event is analysed, the announcement dates of a regulation are the same for all firms, thereby generating a contemporaneous correlation and, as a result, problems of dependence between the residuals. This makes the traditional event methodology invalid. This model establishes an equation for each of the N firms (shares) affected by the various events, which are estimated jointly using the Generalised Least Square (GLS). Thus, taking into account that three events were identified, that the number of firms in the sample is 58 and that the number of analysed days is 307, the proposed system of equations is the following: R1t ¼a1 þ b1 Rmt þ

3 X

c1a Dat þ u1t

with t ¼ 1; . . . ; 307

c2a Dat þ u2t

with t ¼ 1; . . . ; 307

a¼1

R2t ¼a2 þ b2 Rmt þ

3 X a¼1

R58t ¼a58 þ b58 Rmt þ

3 X

c58a Dat þ u58t

with t ¼ 1; . . . ; 307

a¼1

where Rit is the observed return of share i (i = 1, ..., 58) on day t; Rmt is the market return at moment t; ai is a parameter that includes the part of the return of share i that is not due to market variations; bi is a parameter that includes the systematic, non-diversifiable risk of share i; Dat is a dummy variable that takes a value of 1 on the day of event ‘‘a’’ and a value of 0 to the contrary; cia reflects the abnormal return of share i during the day of event ‘‘a’’; and uit is the random term. Therefore, the abnormal return of each share (c) is estimated directly from each equation (Binder 1985a). Based on these returns, the cumulative abnormal return is calculated for each firm, i (CARi = ci1 + ci2 + ci3). MVRM methodology enables us to test both the individual hypothesis for each of the events (H0 : ca = 0), and a joint hypothesis on accumulated P3 return (H0 : a=1cia = 0). The results obtained are presented in Table II. The individual testing of the events indicated a significant and negative abnormal return of ) 0.51% for the first of the events considered. The reason that only the first event induced a significant reaction in the market could be attributed to the fact that the first event revealed most of the relevant information for the formation of investors’ expectations, including the first estimation of costs of compliance. In spite of the opposition to the law by some politicians in the first debate, the market ignored part of the

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Table II. Abnormal Returns and Hypothesis verification (MVRM Model) Event

Date

Mean abnormal returns (ca)

Test H0: ca = 0" a = 1, 3

Event 1 Event 2 Event 3 Event

02/07/2002 04/17/2002 06/14/2002 Date

F(58,302) = 1.33** F(58,302) = 1.02 F(58,302) = 0.76 P Test H0 : 3a¼1 cia ¼ 0

Joint eventa

–

) 0.51% ) 0.01% ) 0.77% Cumulative mean abnormal returns (CARi = ci1 + ci2 + ci3) ) 1.29%**

F(2,302) = 2.59**

**p-value < 5%. As a robustness check we also estimated the model with a (0, +3) event window, obtaining results that were qualitatively similar and that do not alter the conclusions. a

information revealed in following events, including the definitive approval of the law; this may have been due to the fact that the government had an absolute parliamentary majority. The joint hypothesis was rejected in accordance with the test results. The rejection of this hypothesis implies acceptance of the fact that the joint event contained relevant information that was incorporated significantly into the price of the share. Specifically, a cumulative mean abnormal return of ) 1.29% was obtained (with a p-value < 0.05). This negative value for accumulated abnormal performance is maintained if its value is calculated for each of the sectors in the sample (see Table III). The capital market anticipates that adaptation by firms to the provisions of the IPPC Act has a negative impact on their financial results. In other words, investor expectations consider that compliance with the emission limits established by the law before 2007 would require investment that would not be profitable or that would be displacing other types of investments that are directly productive in the traditional sense (Jaffe et al. 1995; Norsworthy 1979; Rose 1983). This would generate costs (as a result of the need to make capital investments) in order to comply with the requirements of a new regulation. In the literature, these costs directly derived from the adaptation process have been broken down into legal costs, costs derived from refocused management attention, the possibility of disrupted production (Jaffe et al. 1995) and costs that concern the technological adaptation of a firm (Reintenga 2000). In general, these results do not differ from those obtained in other studies of environmental legislative processes. Thus, a negative impact has likewise been obtained from other processes in the United States, such as the Superfund Amendments and Reauthorization Act (SARA) for industrial firms in 1986 (Blacconiere and Northcut 1997), the National Environmental

Based on CNAE-93 grouping criteria (Spanish National Classification of Economic Activities). a Firms affected in this sector were those in the field of waste management (Public Health and Sanitation). SD –Standard Deviation. *SD calculated from the individual emisioń data relating to volume in each plant (Ej/Volumej).

[0.013] [0.009] [0.003] [0.013] [0.011] [0.016]

0.019 0.024 0.002 0.002 0.006 0.012

) 0.0108 ) 0.0060 ) 0.0030 ) 0.0080 ) 0.0248 ) 0.0129

9 (15.51%) 8 (13.79%) 3 (5.17%) 6 (10.34%) 11 (18.96%) –

[0.033] [0.012] [0.028] [0.028] [0.025] [0.028]

0.014 [0.027] 0.012 [0.021] 0.008 [0.001]

) 0.0262 [0.025] ) 0.0064 [0.031] ) 0.0053 [0.040]

9 (15.51%) 7 (12.06%) 5 (8.62%)

Paper, wood and chemicals Metallurgy and metal products Construction (Public Health and Sanitation activitiesa) Mechanical, electrical and electronic equipment Petroleum refining, plastics and energy Cement, glass and construction materials Textiles Food, beverage and tobacco Mean

CT/size mean [SD]

CAR mean [SD]

No of firms (%)

Sector

Table III. Description of variables used

0.304 10)4 0.236 10)4 0.128 10)4 0.008 10)4 0.006 10)4 –

[0.082] [0.012] [0.009] [0.003] [0.007]

2.788 10)4 [0.026] 0.578 10)4 [0.013] 0.477 10)4 [0.0001]

Sectoral pollution [SD]*


303

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Protection Act in 1969, or the so-called Clean Air Act Amendments in 1970 (Shane 1995). 3.3.2. Technological capita The stock of R&D expenditures or the stock of technological capital is a variable that takes into account that the intensity of the current technological knowledge of a firm is a direct function of formal and informal technological learning from previous periods, and not just a function of expenditure in the last period (Winter 1987). The process of technological innovation is thus considered to be like a generator of intangible assets that can be accumulated. According to Pakes and Schankeman (1984), technological capital (CTi) is approximated, through a measure of stock that is constructed based on a formulation of the depreciated sums of R&D investment using Koyck lags, and it is represented as follows: CTi ¼

P X

ð1 dÞp R&D Investmenti;p

p¼0

where P is the number of years prior to the current reference year, 2001, in which R&D investments have an impact on the technological capital stock. According to Hirschey and Weygandt (1985), the useful life of an investment is considered to be 5 years, and the depreciation ratio (d) is a constant rate of 20%,6 as recommended by Henderson and Cockburn (1994). R&D Investment is the R&D expenditure in a particular year, as shown in the firm’s Annual Audit.7 This variable has been divided by the net turnover of each firm in the year 2001 (Sizei), since size is considered to be related directly to innovation, given the economies of scale presented by R&D activities (Schumpeter 1961) and the lower risk of carrying out such activities at firms that have more resources (Hitt et al. 1991). 3.3.3. Degree of sectoral pollution Average pollution for each sector was estimated using pollution emission data from the European Pollutant Emission Register (EPER). The register is a requisite of the IPPC directive, so the polluting substances covered by the law are the same as those included in the EPER. More specifically, it collects data per facility on 50 substances that pollute the air and water with a different degree of toxicity.8 The EPER register only includes pollution data from industrial plants that exceed the emission threshold limits whereby it is mandatory for a firm to notify emissions. These notification thresholds are


305

specified in Decision 2000/479/EC for each of the 50 types of pollutant chemical substance considered by the register. In 2001, the EPER registered the different polluting substances of 1,399 industrial facilities in Spain. From the information of these 1,399 plants, we calculated the pollution for each plant j as the sum of the emissions of each of the chemical elements included in the EPER base, weighted by their degree of relative toxicity. According to King and Lenox (2000), relative toxicity was calculated as the inverse of the notification threshold limit. This is a method that has shown a high correlation with other methods such as that proposed by Pardue University (King and Lenox 2000). X wc ecj Ej ¼ 8c

where Ej are the aggregate emissions of each plant j; wc is the relative toxicity for chemical c, calculated as the inverse of its reportable quantity; and ecj are the kilograms of chemical c emitted into the air and/or water per year. The calculation of average emissions by sector (Es) was based on the sum of the emissions of all plants (Ej) of firms from each sector,9 and control of sector size was achieved by making the figure relative to the total production volume of each sector. P Ej 8j Es ¼ P Volumej 8j

The values of this sectoral pollution index and the rest of the calculated variables are presented in Table III. According to the sector-specific means presented on Table III, the abnormal returns (CAR) do not appear to be closely related either to pollution level or technological capital. However, we cannot rule out the possibility of such relationships when considering individual data. Indeed, investors may base their profit or loss expectations on pollution levels and technological knowledge compared with other firms in the same sector. 3.3.4. Model and methodology Based on the above variables, a model has been constructed to verify the influence of technological capital on the reaction of investors in view of the announcement of a new law: CARi ¼ d0 þ d1

CTi þd2 Es Sizei

306


where CARi is the dependent variable corresponding to the cumulative abnormal returns for each firm, i, derived from the events pertaining to implementation of the IPPC (CARi = c i1 + ci2 + ci3). Variable CTi/Sizei, represents the technological capital or R&D stock (CTi) of the firm, i, relative to its net turnover (Sizei). Finally, variable Es reflects the level of sectoral pollution. The model is verified by an Ordinary Least Square (OLS) regression for the sample of 58 firms. 4. Results Table IV shows the results of three regressions: the first is with all the explanatory variables (the model put forward in the previous section); the other two have each explanatory variable entered separately. When the model is analysed with both explanatory variables (the first column of Table IV), it can be noted that the coefficient of the technological capital variable has a positive and significant value (c21 = 0.236). In contrast, the Sectoral Pollution variable has a negative (although not significant) effect on the dependent variable. These results are confirmed when each of the explanatory variables are studied separately (second and third columns): the level of sectoral pollution has a negative but insignificant effect on the abnormal accumulated performance of the sample firms while the significance of Technological Capital is maintained. For its part, the model that only includes this variable shows the highest adjusted R squared (9.5%), which shows that this model improves on the one presented in the first two columns. Concentrating on this, we find that an increase of 1% in Technological Capital allows for a 0.238% improvement in the abnormal return of the firm. As in our case abnormal returns were negative, this improvement implies a smaller loss in abnormal returns. Table IV. OLS Estimate dependent variable: CAR Variable (v)

Coefficient cv1 (t-statistic)



Constant ) 0.013*** ()2.970) ) 0.012*** () 2.578) ) 0.014*** () 4.026) Technological capital 0.236** (1.806) – 0.238** (1.833) (CTi/Sizei) ) 0.071 () 0.540) – Sectorial pollution (Es) ) 0.081 () 0.763) Adj. R2 8.7% 6.2% 9.5% F 2.893** 1.302 3.401*** ***p-value < 0.01; **p-value < 0.05. Correlation between the explanatory variables = ) 0.028.


307

Therefore, as suggested in our hypothesis, the availability of greater technical knowledge within the company moderates its vulnerability in the face of the demands of new environmental regulations. The availability of greater technological knowledge on the part of a firm implies an innovative trend (R&D intensive firm). Consequently, these companies will find it easier to adopt new technologies. As Battisti and Stoneman (2005) argue, the firm’s adoption of new technology will be determined by firm-specific capabilities which include, among other things, technological capabilities. Companies that have this capacity/knowledge at their disposal could probably use them to make new investment required to adapt to the new environmental requirements. As a result, they would generate a series of complementarities which would facilitate adaptation and reduce the cost of accommodating a firm’s production process to a new regulation (King and Lenox 2000; Nakamura et al. 2001). Indeed, some of the more innovative firms may already have the appropriate technology. Conversely, the market anticipates greater costs at less innovative firms, which have less technological capital for adapting to a new regulation. The availability of this (inferior) technological capital would reflect the fact that these firms have less knowledge that could be used in the adoption and/or use of the new investments required: they would face greater difficulties in adequately complying with the new environmental regulations. This would especially be the case when there is a time limit involved, as is the case with the IPPC Act. This could result in diseconomies for the firms as they would have to implement technologies hastily in order to comply with a regulation (Ashford 1993; Nehrt 1996, 1998) or when attempting to redesign their processes in order to adapt to the legislation. These firms may opt for correction strategies at the end of the process or reactive strategies. These kinds of strategies are more accessible and less costly in the short-term, but they are not very profitable in the long-term, given that they leave products and processes unchanged. In addition, as some firms might decide to put off adaptation on the basis that the technologies may become widespread and therefore cheaper, they would be functioning in the meantime in inefficient conditions. In short, the availability of greater technological capital on the part of a firm will allow it to experience a smaller reduction in value and this is due to its greater ability to adapt to the new requirements imposed by the Act. On the other hand, as we have already indicated, Sectorial Pollution does not affect abnormal results significantly: firms in highly polluting sectors do not experience a much greater reduction in value than those operating in less pollutant sectors. Although initially this result may seem unexpected, note that the IPPC law concentrates on activities that generate pollution, so all the sectors analysed in this study share this characteristic. The fact that the Sectorial Pollution variable was not significant would indicate that the market

308


does not discriminate according to the sectorial pollution level. This could be explained by the fact that this level of pollution only represents an approximation of the pollution problems faced by each company. Indeed, EPER data suggest high pollution variability across plants within the same sector – as shown by the magnitude of the standard deviations presented in Table III. 5. Conclusions and Implications This paper attempts to respond to the question of how technological knowledge moderates the effect that the implementation of a new environmental regulation (the Integrated Pollution Prevention and Control Act) has on the results of affected firms. Up to now, studies on the subject have mainly been directed at evaluating the financial consequences derived from implementing a new regulation. However, they have not taken into account the extent to which the prior possession of certain resources related to technological knowledge and innovation facilitates adaptation by a firm. This is precisely the reason for this study. We have studied the repercussions of this regulatory process on the market value of the Spanish firms in the sample. Specifically, we found that investor expectations are that firms’ adaptation to the requirements of the IPPC Act will have a negative impact on financial results. This may be due to the increased costs involved in the adaptation process. In accordance with Klassen and McLaughlin (1996) we estimated that the variation in the market value of equity due to the legislative event for our total sample was a loss of approximately 1,700 million euros. Based on this first result, we analysed the extent to which the available technological capital of a firm affects its abnormal returns. We found that firms with greater technological capital (more innovative companies) experience a smaller reduction in their market value. So, investment in research and development has a positive effect on more than just financial results, and therefore on competitive advantage, as it has been studied to date. Indeed, the most important implication of this paper is that technological knowledge prepares a firm for adapting to the greater environmental demands derived from new legislation. Managers should take into account the importance of innovation, which enables more efficient adaptation and is less likely to place a firm’s competitive position at risk.

Notes 1. The applicable scope of the Act includes metal combustion, production and processing facilities; mineral industries; chemical industries; the waste management industry; the paper


2. 3.

4. 5.

6.

7. 8.

9.

309

and cardboard industry; the textile industry; the leather industry; the agri-food and livestock industries; the use of organic solvents and the coal industry. These techniques are specified in the European Best Available Techniques Reference Documents (BREFs). Cooperation is a necessary condition for a flexible regulation (Harrison 1995). This is why American regulations that imposed specific technological and environmental processes were at a disadvantage in comparison to countries such as Canada, where there was a much more cooperative relationship between the firm and the regulator (Rugman and Verbeke 1998). Firms listed on the stock exchange are usually large companies, a fact that might limit the generalisation of our results to other, small or medium sized companies. The number of industrial facilities affected by the IPPC Act and corresponding to these 58 firms is 168 of a total of 5,299 Spanish industrial plants affected by the Act (sample error ± 7.59%, confidence level = 95.5%). This model presents a constant depreciation ratio over time. Thus, it assumes a strictly decreasing influence by R&D expenses on the stock over time. The R&D stock of a certain year will then be equal to the stock of the preceding year, net depreciation, plus that year’s investment StockT = InversiońT + (1 ) d)StockT-1. The type of R&D activity undertaken by the firms is not detailed in the Annual Audits. Air pollutants include CO2, CO, NOx, NH3, N2O, Cr and compounds, Pb and compounds, Cd and compounds etc. Water pollutants include Chlorides, Cyanides, Fluorides, As and compounds Cu and compounds etc. All these polluting substances are covered by the IPPC Act. Each plant is assigned to the sector of the parent company, in line with information included in the EPER. Sector classification is based on the CNAE-93 grouping criteria (National Classification of Economic Activities – the official Spanish classification of sectors).

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