Environmental Regulation and Firm Efficiency: Studying the Porter Hypothesis using a Directional Output Distance Function

The purpose of this paper is to suggest a procedure to empirically test the Porter hypothesis. This hypothesis argues that environmental regulation not only increases environmental quality, but also brings the polluting producers information that makes them more resource efficient, as well as able to develop new technologies. Specifically, the hypothesis tested is whether there is a positive significant correlation between producers’ technical output efficiency and environmental regulation. Efficiency is first estimated using a methodology where the production technology is represented by a directional output distance function, which credits a simultaneous expansion of market goods and contraction of emissions. Then, by regressing the obtained efficiency scores on an index that approximates environmental regulatory intensity, the Porter hypothesis is explicitly tested. The test procedure is applied on 12 Swedish pulp plants during 1983-1990. The result shows no support for the Porter hypothesis.