Annex C – Consultation Response
Exploring the relationship between environmental performance and competitiveness
A research report completed for the Department for Environment, Food and Rural Affairs by Metroeconomica Ltd.
SCP Evidence Base: Exploring the relationship between environment and competitiveness
Sustainable Consumption and Production Evidence Base:
Exploring the relationship between environment and competitiveness
Final Report
March 2006
Presented to:
Department of Environment, Food and Rural Affairs
Prepared by:
Metroeconomica LimitedIn collaboration with
Paul Watkiss Associates
Final Report - 3 -
SCP Evidence Base: Exploring the relationship between environment and competitiveness
Sustainable Consumption and Production Evidence Base:
Environment and Competitiveness Links
Suggested citation for this report:
Boyd, R., Ferguson, J., Hunt, A., Taylor, T. Walton, H. and Watkiss, P, 2006. Exploring the relationship between environment and competitiveness. A research report to the Department for Environment, Food and Rural Affairs by Metroeconomica Ltd. Defra, London.
This Final Report has been prepared by:
Richard Boyd, Julia Ferguson, Alistair Hunt, Tim Taylor and Harry Walton / Metroeconomica LimitedPaul Watkiss / Paul Watkiss Associates
All enquiries relating to the report should be referred to the Project Manager:
ALISTAIR HUNTMetroeconomica Limited, 108 Bloomfield Road, Bath, BA2 2AR.
Telephone: +44 (0)1225 383244 Fax: +44 (0)1225 462678 Email:
Final Report (Version 1) - 4 -
SCP Evidence Base: Exploring the relationship between environment and competitiveness
Executive Summary
Metroeconomica Limited was commissioned by the Department for the Environment, Food and Rural Affairs to conduct a literature review of the evidence on linkages between business environmental performance and business financial performance. The review aimed at assessing the extent to which common perceptions and questions about these linkages can be addressed given the state-of-the-art knowledge base.
Around one-hundred relevant papers were identified and reviewed. This sample encompassed previous literature reviews, empirical studies, qualitative and quantitative case studies, surveys, theoretical and discussion papers, and pieces based on expert opinion. Over half of the papers were of European origin, and about one third of North American/Canadian origin.
Definition and Measurement of the Key Variables
The term competitiveness does not have a universally accepted definition, and captures many aspects of financial performance. Consequently, researchers have tended to investigate links between firm environmental performance and a variety of metrics for measuring the financial performance of a firm. Regarding the latter, researchers have taken a pragmatic approach and used the information that is most accessible, which tended to be that relating to firm market values. Thus the highest proportion of studies reviewed use some form of share price metric as their measure of financial performance.
There is also considerable variety in the definition of environmental performance: a diverse number of metrics were used, which can be grouped as follows:
1. Those concerned with environmental pollution, either in terms of actual emission levels, or in terms of enforcement actions, penalties and liabilities.
2. Those concerned with environmental initiatives, such as levels of expenditure on pollution prevention or the implementation of environmental management systems or other proactive environmental strategies.
3. Those that use a number of different approaches to measure and evaluate various aspects of environmental performance within a single framework. Typically, each framework incorporates a range of indicators relating to both (1) and (2) above.
In summary, in the papers reviewed a wide variety of financial performance metrics were tested against an equally wide array of environmental performance metrics.
Methodological Issues
About half of the papers reviewed were empirical studies, which used one of three approaches: portfolio (investment) analysis, event studies, or panel or cross-sectional studies based on more or less sophisticated regression analyses. A number of methodological concerns have been raised about these approaches, and research in this area more generally. For example, while simple correlation and multiple regression analyses reveal dependence between one variable and others, they cannot tell us anything definitive about cause and effect – that is, whether improved environmental performance leads to enhanced firm competitiveness. Most of the concerns relate to the nature of the data that is available, and the extent to which factors that moderate the linkage between environmental performance and financial performance have been included in the analysis.
A significant number of papers also used case studies which, in theory, offer more insight into the way, and under what circumstances, firm environmental performance interacts with financial performance. However, in practice, few of the case studies lived up to this potential.
In general, the research question most frequently asked was simply whether or not firm environmental activities affect financial performance. Few researchers concerned themselves with exactly how, or the process by which, environmental performance may affect competitiveness.
The robustness of the results in the literature should therefore be viewed in the context of these methodological concerns.
Key Findings
Overall, the majority of the literature reviewed supports a positive link between improved environmental performance and enhanced firm financial performance. In light of the methodological concerns, however, the quality of this evidence is at best ‘moderate’.
None of the papers reviewed adequately addressed or proved causality. That is, it cannot be said with any confidence that improvements in firm environmental performance ‘cause’ improvements in firm financial performance. There is nonetheless some evidence to suggest a virtuous cycle of financial and environmental performance. From a pragmatic perspective, some authors argue that evidence of co-occurrence of improved environmental and financial performance should provide a sufficient basis upon which to build a business case for action.
From the papers reviewed it was possible to make some conclusions regarding the links between broad aspects of environmental performance and specific improvements to firm competitiveness. There is some evidence in the literature that pollution prevention (i.e. source reduction) is associated with operational cost savings and lower capital financing costs, and limited evidence that pollution prevention increases firm revenues. There is also some evidence that end-of-pipe pollution treatment and control measures, in contrast, increase operational costs. Again, this evidence may at best be characterised as being of ‘moderate’ quality.
There was also some evidence that proactive environmental strategies were associated with stronger financial gains, compared with ‘compliance only’ strategies. And firms that employed innovative proprietary approaches to pollution prevention revealed stronger gains than firms that adopted ‘best practice’ industry standards. A limited set of evidence also confirmed competitive advantage for ‘early movers’.
No evidence was found that either directly or indirectly addressed the question of whether certain threshold levels of environmental performance needed to be achieved before financial performance was affected.
Only a few studies looked specifically at the small and medium size business sector; most of the studies have focused on large, publicly quoted companies, and no studies actually set out to contrast the two. The findings of the few studies that focused on smaller firms were similar to those found for larger firms – that is, improved environmental performance was associated with a positive impact on competitiveness, and most small firms benefited financially from pollution prevention measures as opposed to end-of-pipe pollution treatment and control.
There is very limited, good quality, evidence that investment in pollution prevention measures, even when yielding positive rates of return, do not necessarily represent clear-cut financial winners. That is, they yield a lower rate of return than alternative, equally risky, projects among a firm’s portfolio of investment opportunities.
Finally, many studies comment on the barriers to improving environmental performance. These include:
· The need to improve the information that will help to build the business case for improving environmental performance, and mechanisms to disseminate this information, where available.
· The need for improved definition of environmental performance, both to assist researchers in building the business case and to help firms see what specific environmental activities are linked with enhanced competitiveness, and under what circumstances.
· The need for standardised reporting language and formats. Without such mechanisms, the information required by both businesses and the financial community for decision making is not easily accessible.
· The need for better advice and guidance for businesses.
Small firms, specifically, need assistance to overcome informational and capital constraints, and skill gaps, in order to identify and exploit the cost savings potential of pollution prevention measures.
Proposed Research & Policy Agenda
In relation to policy, it is important to help firms collate suitable information to evaluate the relative (financial) merit of environmental initiatives, and to consider how to strengthen any positive association, especially compared with alternative use of firm resources. Policy should focus on:
· Helping firms unearth pollution prevention projects. The identification of such opportunities is a significant challenge for business; and
· Ways to enhance the profitability of pollution prevention projects; for example, through the promotion of state-of-the-art (environmental) cost accounting practices, including materials accounting. Equally, the profitability of pollution prevention projects could be improved by raising the cost of polluting activities (e.g. through increased internalisation of pollution externalities or eliminating perverse subsidies), or by promoting research that seeks to measure the intangible benefits (e.g. market and reputation advantages) of good environmental performance in monetary terms, so that they can be included in standard financial appraisal.
The trend in business towards thinking about commercial success in terms of developing stakeholder value provides opportunities for the SCP policy agenda. This trend places a less exclusive focus on creating shareholder value and a stronger emphasis on the community and customers, a well as relationships up and down the supply chain. In terms of policy development, it opens up opportunities to move away from an exclusive focus on persuading firms of the business case for improving environmental performance, and towards using broader stakeholder communities to influence businesses. The stakeholder with the capacity to provide the most leverage on business is the consumer, and governments have the capacity to shape both consumer attitudes and behaviour.
The study identified a number of gaps in the evidence base. Of primary importance, it is very clear that not enough is known about when and for whom it pays to improve environmental performance. This is not only important for firms - to help identify and prioritise environmental actions - but also for government, in the development of more effective SCP policy (employing targeted regulations and incentives that provide the most leverage). Specific avenues for future research include:
1. Intra-sectoral studies that investigate in a more systematic and rigorous way specific linkages hitherto identified. These studies may be categorised according to the nature of the environmental issue addressed. The principal issues that such a series of studies could address in more detail than has been attempted to date are: the identification and analysis of variables that have been previously omitted or shown to have a confounding influence; causation and the role of management structures, including EMS, and; barriers to up-take of financially viable environmental improvements.
2. Sectoral based research on barriers relating to up-take of environmental improvement. Some work on this topic, in connection with barriers to adopting energy efficiency measures, has already been done and could be complemented by work on, e.g. waste management. The current study has identified that the operation of such barriers is most notable in small and medium-sized enterprises, (SMEs), where informational and scale barriers are significant.
3. Cross-sectional research into the role on internal and external information systems. A formal analysis of the costs and benefits of information services and environmental management systems would shed light on the role of these factors in facilitating environmental improvement.
4. Establishment of metrics to allow development of (reported) time-series data. Such agreed (and adopted) metrics, particularly of environmental performance would facilitate much greater reliability in the analysis of sectoral and cross-sectoral trends than has been possible in the studies reported above.
5. Detailed case studies across a range of sectors and firm sizes, in which business decision-making generally and environmental performance decision-making specifically is studied to understand the process and circumstances leading to the implementation of (or failure to implement) pollution prevention measures. This is necessary in order to further explore how increases in productivity resulting from environmental initiatives rank against other improvements in productivity that firms could make.
Table of Contents
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SCP Evidence Base: Exploring the relationship between environment and competitiveness
1 Introduction 1
1.1 Background 1
1.2 Objective 2
1.3 Approach Taken 3
1.3.1 Broad Characterisation of the Literature 4
1.3.2 Analytical Framework 5
1.4 Structure of the Report 8
2 Definitions and Methods 9
2.1 Introduction 9
2.2 Definitions of Environmental Performance 9
2.2.1 Metrics of ‘Negative’ Environmental Performance 10
2.2.2 Metrics of ‘Positive’ Environmental Performance 10
2.2.3 Indices of Environmental Performance 11
2.3 Definition of Competitiveness 13
2.4 Methodological Issues 16
2.4.1 Broad Types of Study 16
2.4.2 Robustness of Empirical Studies 17
3 Exploring the Links between Environmental and Financial Performance 23
3.1 Introduction 23
3.2 Literature Reviews 23
3.3 Empirical Studies 28
3.3.1 Investment Portfolio Studies 29
3.3.2 Event Studies 30
3.3.3 Panel and Cross-sectional Studies 33
3.4 Non-empirical Papers 40
3.4.1 The Business Case for Improving Environmental Performance 40
3.4.2 Impacts of Environmental Management Systems and Reporting 41
4 When and For Whom Does it Pay to be Green 45
4.1 Introduction 45
4.1.1 Impact of Different Environmental Initiatives 45
4.1.2 The Presence of Threshold Effects 49
4.1.3 Impact of Industry Sector or Firm Size 49
4.1.4 Relative Productivity Gains 50
4.2 Barriers to the Uptake of Environmental Initiatives 52