Do Environmental Regulations Do More Harm Than Good? Evidence from Competition and Innovation

Abstract

This study examines whether and how competition affects corporate strategic responses to stringent environmental policies. Using the nonattainment status of U.S. counties as a source of exogenous variation in environmental regulation, we find that competition fosters green innovation as firms respond to stricter regulatory policy. Additional analyses using a subsample of firms in counties whose pollutant concentrations are marginally above or below EPA standards for regional air quality and exploiting exogenous variations in product market competition further reinforce our baseline evidence. The results suggest that the cost of relocation is a critical mechanism that compels firms to innovate when responding to tightened environmental policies and heightened competitive pressure. Regulation-induced green innovation helps competitive firms better achieve product differentiation and attract more corporate customers than their less competitive peers. Finally, competitive firms' strategic responses to stringent environmental regulations result in improved market share growth, markup, profit margin, and abnormal return.