Journal of Cleaner Production 258 (2020) 120579

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Journal of Cleaner Production

journal homepage: www.elsevier.com/locate/jclepro

External and internal economic impacts of eco-innovation and the

role of political connections: A sustainability narrative from an
emerging market
Gracezelda Latupeirissa , Desi Adhariani *
Department of Accounting, Faculty of Economics and Business, Universitas Indonesia, Indonesia

a r t i c l e i n f o a b s t r a c t

Article history: Eco-innovation is an evolving area of research and might have practical implications for cleaner pro-
Received 12 June 2019 duction. While the identification of eco-innovation’s economic consequences has been widely investi-
Received in revised form gated in the extant literature, many questions remain regarding its impact in the context of developing
11 February 2020
countries. This study investigates the effects of eco-innovation on the cost of equity capital and corporate
Accepted 13 February 2020
financial performance as well as the role of political connections as a moderating variable in Indonesia as
Available online 15 February 2020
an emerging market. The samples are all nonfinancial companies listed on the Indonesian Stock Ex-
Handling editor: Charbel Jose Chiappetta change from 2011 to 2016. The data are processed using the panel regression method. This study finds
Jabbour that eco-innovation does not affect the cost of equity capital or company performance. However, political
connections do, and they moderate the association between eco-innovation and the cost of equity capital
Keywords: but in a positive direction. This implies that political connections cannot generate investor trust via the
Eco-innovation eco-innovation efforts of companies.
Cost of equity © 2020 Elsevier Ltd. All rights reserved.
Financial performance
Political connections

1. Introduction involves the public disclosure of information pertaining to the

For business survival, global competition demands that com-
panies innovate. Firm innovation involves new ways of thinking as
regards providing technological, economic, and social solutions
related to current operations (Albu and Stelea, 2015). These new
mindsetsdmotivated by the need to compete for survivald urge
businesses to pursue all means of improving their performance
without necessarily considering the natural environment.
For example, in the context of Indonesia, according to the
Indonesian Ministry of Environment and Forestry, in 2015, 269
mining, manufacturing, energy, oil, gas, infrastructure, services, and
agribusiness companies generated 125,540,827.76 tons of hazard-
ous and toxic waste. This demonstrates a continued lack of atten-
tion paid to the natural environment. To overcome this, various
government efforts have been promulgated, including the launch-
ing of the Rating of Company Performance (PROPER) program,
implemented to promote firm compliance to legislation. This
* Corresponding author.
E-mail addresses: sesillatu@gmail.com (G. Latupeirissa), desi.adhariani@ui.ac.id,
desi.adhariani@ui.ac.id (D. Adhariani).
environmental performance of companies. The program is driven
by a reputational incentive linked to environmental performance.
Thus, companies are pressured to build or maintain a good repu-
tation for market survival. It is generally thought that companies
concerned with environmental performance will generate more
profits, which will ultimately help them survive longer in the global
marketplace (Fernando and Wah, 2017). Therefore, innovation is a
good way of improving environmental performance.
Appropriate eco-innovation efforts, in the right combinations,
boost both company and environmental performance. Sarkar
(2013) outlined many benefits for innovators of eco-innovation,
including image, supplier relationships, customers, and author-
ities (i.e., indirect benefits). There are also operational benefits,
such as cost savings from greater resource productivity and better
logistics and sales from commercialization (i.e., direct benefits).
Eco-innovation behavior’s impact on a firm’s environmental per-
formance was documented in several studies, including Cai and Li
(2018) and Salim et al. (2019). Financial benefits were docu-
mented by Cheng et al. (2014), Przychodzen and Przychodzen
(2015), and Ryszko (2016).
Research on the contexts of emerging markets has also been
performed. According to Latan et al. (2018), organizational

https://doi.org/10.1016/j.jclepro.2020.120579
0959-6526/© 2020 Elsevier Ltd. All rights reserved.
2 G. Latupeirissa, D. Adhariani / Journal of Cleaner Production 258 (2020) 120579
resources had a positive impact, comprising corporate environ-
mental strategy, top management commitment, and environ-
mental uncertainty regarding the use of environmental
management accounting, which in turn might improve the envi-
ronmental performance of companies in Indonesia. Upon
comparing eco-innovation and business performance in emerging
and developed economies, Santos et al. (2019) found that nearly all
environmental and social eco-innovation variables were significant
in their respective dimensions in the developed countries, while
only two environmental and social variables were significant in
emerging countries. This highlights the more advanced stage of
eco-innovation in developed countries. Using a case study
approach, Aloise and Macke (2017) found that eco-innovation ini-
tiatives are still scarce in developing countries. Among those rare
efforts, a case study from Fernando et al. (2016) on furniture
manufacturers in Indonesia, which represented small to medium
enterprises, indicated that a green network is an emerging driver
that might contribute to eco-innovative practices, aside from other
factors such as regulation, technology, and firm-specific market and
supply factors. However, another case study from Susilawati and
Kanowski (2019) in an Indonesian pulp and paper value chain,
which represents a large enterprise, suggested that high levels of
compliance with sustainability and legality requirements were only
demonstrated in audit reports, while their fieldwork indicated that
these reports might not reflect some areas of poor performance and
non-compliance.
Other studies in the context of developing countries are needed
to confirm the stage, which also motivated us to perform this
research. In contrast, the impact of eco-innovation on the cost of
equity is another topic that has been rarely studied. El Ghoul et al.
(2011) and Hajawiyah et al. (2019) researched the relationship
between corporate social responsibility (CSR) and the cost of cap-
ital. However, because CSR is not necessarily an eco-innovation, a
research gap remains.
Given the many benefits available to Indonesian companies that
eco-innovate, this study examines its external effects on the cost of
equity capital and its internal effects on financial performance. In
Indonesia, PROPER compliance is in its infancy. A study conducted
in an emerging market such as ours should encourage more firms
to innovate.
Apart from the research gap, political connections raise ques-
tions of “effect”. In Indonesia, companies incur costs related to
processing and storing waste per PP No.100, 2014. Given that
government regulations often change, firms address the uncer-
tainty by seeking added value, such as political connections. In the
extant literature, political connections are defined as connections
by members of a company’s board of commissioners and directors
who had or are currently serving as heads of the central or regional
governments, legislative members, ministers or ranks of cabinet,
political party officials, or other political positions, such as mem-
bers of the military and ambassadors, as disclosed in annual reports
(Faccio, 2006; Fan et al., 2007; Habib et al., 2017). These connec-
tions are important and incentivize companies to improve perfor-
mance. However, political connections can both strengthen and
weaken environmental innovation and impact performance and
the cost of equity capital. Political connections can weaken envi-
ronmental efforts when companies leverage them to avoid regu-
lation offenses. Conversely, they can strengthen efforts when
companies use them to promote innovation and teamwork with the
government. Besides examining the effects of eco-innovation on
equity and performance capital costs, this study examines the role
of political connections on the cost of equity, eco-innovation, and
performance, and it studies the moderating effect of political con-
nections between eco-innovation and equity capital costs and
company performance.
This study answers several research questions. “Does eco-
innovation impact the cost of equity and financial performance
(‘the two variables’)?” “Does political connection impact the two
variables?” While the two questions have been widely answered in
previous research in a variety of contexts (Przychodzen and
Przychodzen, 2015; Boubakri et al., 2012), the present research
focuses on other scarcely-addressed questions related to political
connections: “Do political connections drive eco-innovation?” and
“Can political connections moderate the association between eco-
innovation and the two variables?” Bitencourt et al. (2020) per-
formed a meta-analytical review of eco-innovation, including an
examination of its drivers and moderators, but did not mention
political connections as a variable. Bringing these factors into the
arena of eco-innovation research will advance the literature in this
regard. Hazarika and Zhang (2019) found that regulatory instru-
mentsdthe set of techniques implemented by the governmentd-
play an integral role in encouraging companies to pursue eco-
innovation. Based on this finding, a premise regarding political
connections, which includes connections with the government, can
be developed and become the normal reasoning behind the eco-
innovation incentive. The method used to answer the research
questions is quantitative panel regression based on 220 and 223
companies listed in the Indonesian Stock Exchange (IDX) from 2011
to 2016.
By investigating the eco-innovation issue and answering the
research questions, this study provides theoretical and practical
contributions. The theoretical contributions are twofold. First, this
research fills a research gap on the impact of eco-innovation on the
cost of equity as an external impact. This topic is relevant to un-
derstanding how eco-innovation initiatives can be appropriately
appreciated in an emerging market, especially Indonesia’s. Second,
given the dearth of eco-innovation research in emerging countries,
this study is expected to contribute to the literature of eco-
innovation and its economic impact. Third, this study contributes
to the literature of political connections by examining its impact on
eco-innovation and its role in moderating eco-innovation and in-
ternal and external factors. Practically, this study contributes to the
practice of eco-innovation initiatives by presenting the types of
innovation that have been conducted by Indonesian companies. We
also analyze the benefits on the cost of equity and financial
performance.
This paper is structured as follows: Section 2 discusses the un-
derpinning theory of this research by citing previous literature,
leading to hypothesis development. Section 3 presents the research
method, followed by results and discussions. A conclusion is pro-
vided in Section 5 with research implications and limitations.
2. Theoretical perspective
Stakeholder theory is often used as the basis of research related
to sustainability performance (Rezaee, 2016) and factors affecting
eco-innovation (Hojnik and Ruzzier, 2016). It argues that com-
panies should pay attention to all stakeholders (Jensen, 2002).
According to Freeman (1999 p.41), a stakeholder is any group or
individual influenced by or affecting the achievement of a com-
pany’s organizational goals. Stakeholders are important for eco-
innovation. They comprise shareholders, customers, employees,
suppliers, distributors, and local communities (Freeman, 1999). In
this respect, eco-innovation is considered a company’s response to
external demands from stakeholders rather than an internal
mechanism to exploit or explore new markets (Santos et al., 2019).
Apart from stakeholder theory, related to eco-innovation, the
resource-based theory is commonly used. This theory states that a
company’s internal resources are its fundamental strengths in
terms of running the business or implementing the strategy
 G. Latupeirissa, D. Adhariani / Journal of Cleaner Production 258 (2020) 120579
(Barney, 1991). A company’s resources include its assets, capabil-
ities, organizational processes, organizational completeness, infor-
mation, and knowledge, etc. Most variance in company
performance can be attributed to the distribution of resources and
the heterogeneous capabilities of competitors, with industry and
markets playing relatively minor roles (Masakure et al., 2009). The
efficient distribution, utilization, and preservation of resources
offer a way to reduce adverse environmental impacts, whereas eco-
innovation provides firms with opportunities to enhance their
competitive advantage.
Eco-innovation as a business strategy focuses on increasing
corporate profits while improving and preserving the ecology. Eco-
innovation comprises part of a larger innovation, but it adopts an
environmentally responsible approach to achieving positive and
direct economic and environmental results (Albu and Stelea, 2015).
Pujari et al. (2003) summarized methods in which companies
benefit from environmental improvements, such as increased sales,
better consumer responsiveness, better customer proximity, and
better corporate reputation. Environmental innovations comprise
the development of new products, processes, techniques, practices,
and systems aiming to avoid adverse environmental impacts (Beise
and Rennings, 2005). Eco-innovation highlights the behavior of the
actors of innovation (e.g., innovators and companies) in terms of
their pursuit of the dual objectives of ensuring economic perfor-
mance while maintaining responsibility for their environment.
Their actions have direct and indirect positive impacts on the
environment via the development of ecological improvements
(Albu and Stelea, 2015; Halila and Rundquist, 2011).
There are several types of eco-innovation. First, organizational
eco-innovation is achieved through the development of training
and education programs that focus on environmental management
and innovative product design. Another type includes organiza-
tional efforts to reduce social and economic impacts via product
and relationship improvements with stakeholders (Brasil et al.,
2016). Eco-innovation is undertaken by redesigning and devel-
oping products that use less energy, reduces waste, and contains
fewer substances harmful to human health (Brasil et al., 2016).
Process eco-innovation refers to measures, such as reusing raw-
materials, recycling for human health, and reducing negative
environmental impacts (Brasil et al., 2016). Marketing eco-
innovation (Halila and Rundquist, 2011) involves new marketing
methods that result in changes to the design or impression of a
product in terms of its placement, promotion, or price. Attention is
paid to the principle of the environment or the formation of
ecological awareness as part of the promotion (e.g., an eco-label).
This could take the form of a green brand, used for improved
commercialization of products or services.
Environmental policy in Indonesia addresses the importance of
the roles played by industry in the preservation of the natural
environment. Law no. 5, 1984, was revised to Law no.3, 2014. Article
30 lists industry rules, including the obligation to process and
utilize natural resources efficiently and in environmentally friendly
and sustainable ways. For violations, Law no.3, 2014, art. 30, para. 5,
outlines sanctions ranging from written warnings to business-
license suspension.
2.1. Previous research and hypothesis development
Since previous research on the association between eco-
innovation and the cost of equity is still scarce, this study’s first
hypothesis is based on carbon research, a part of environmental
innovation. Kim et al. (2015) found that firms with a lower carbon
risk had lower equity capital costs because of their reporting re-
quirements. As such, the higher a company’s carbon emissions, the
greater the cost incurred (e.g., lawsuits). Contradictorily, Li et al.
3
(2014) found that reducing carbon emissions did not affect the
cost of equity capital, because the concept of reducing environ-
mental impacts through the reduction of carbon emissions remains
relatively new. Thus, there is a delay in the market’s reaction to
such information, and there is a lack of understanding of the pos-
itive environmental impacts of the reduction of carbon emissions.
This leads to the first hypothesis.
H1. Eco-innovation has a negative effect on the cost of equity
capital.
Eco-innovation affects company performance (Przychodzen and
Przychodzen, 2015; Brasil et al., 2016). Companies that consider
eco-innovation tend to also address regulation and consumer
perception concerns (Doran and Ryan, 2012). Companies are
increasingly seeking to embrace innovations that bolster their
environmentally-friendly credentials to improve their financial
performance by increasing their appeal to and thus demand from,
consumers who care about the environment. Przychodzen and
Przychodzen (2015) added that companies that engaged in eco-
innovation had higher levels of profitability and were more likely
to face lower exposure risks. Research by Brasil et al. (2016) found
that each type of eco-innovation was both a determinant of and a
contributor to business performance. Apart from increased sales,
corporate profits can be increased by reducing greenhouse gas
emissions via reduced production costs (Nishitani et al., 2017). This
leads to the second hypothesis.
H2. Eco-innovation has a positive effect on the company’s finan-
cial performance.
In Indonesia, the environmental regulations of Law no.3, 2014,
art. 30 provide rules for industry players. Industrial companies
must process and utilize natural resources in an efficient, envi-
ronmentally friendly, and sustainable way. For actors violating
these obligations, para. 5 of the law provides sanctions beginning
with a written warning. The worst case includes the suspension of
the firm’s business license. Via government regulation, it is easily
assumed that eco-innovation provides the benefit of helping pro-
tect the surrounding environment. Unfortunately, it is costly to
apply continuous innovation, and this is where corporate political
connections come into play. Li et al. (2018) stated that companies
with political connections benefited from more subsidies than
those with none. A company with connections can be expected to
improve innovation, including eco-innovation. Tsai and Xu (2018)
found that companies with strong political connections innovated
more as they received larger government subsidies. In line with
resource-based theory, political connections is one type of com-
pany resource that can provide benefits to companies as regards
accessing new information about government policy, making
obtaining investment capital easier, improving tax administration,
and increasing government subsidies for conducting business.
Unlike Tsai and Zang, however, Han (2019) found that CEOs with
political connections tended to have lower levels of innovation. This
is because CEOs with political connections adopted a more flexible
employment policy, which in turn meant that they had a lower
level of innovation output from their employees. Since previous
studies present mixed evidence, the present study’s hypothesis is
based on the resource-based theory, that is, political connections
are expected to positively affect eco-innovation. This leads to the
third hypothesis.
H3. Political connections positively affect eco-innovation.
In developing countries like Indonesia, the government is the
main driver of economic development. Thus, all government pol-
icies greatly affect the activities of a firm. Political connections play
4 G. Latupeirissa, D. Adhariani / Journal of Cleaner Production 258 (2020) 120579
an important role in these activities, including the reduction of
equity costs. Boubakri et al. (2012) found that firms with political
connections had lower equity capital than unrelated companies
because shareholders viewed companies with political connections
as having a lower risk than companies with none. Furthermore,
they found that political connections had a stronger effect in terms
of lowering the cost of equity capital in large and older companies
and those located in countries with lower freedoms of the press,
weaker democracies, higher corruption, limited stock market
growth, and a greater probability of economic depression. This
leads to the fourth hypothesis.
H4. Political connections have a negative effect on the cost of
equity capital.
Maintaining good relations with the government creates valu-
able social capital for businesspersons (Ling et al., 2016). The ease
with which firms can access information and bureaucratic benefits
directly impacts their corporate performance. Zhang (2017) argued
that political connections could provide an opportunity for com-
panies to modify or influence future government policies and
regulations in the sense that the company could lobby or bargain
with the government. This would affect the company’s perfor-
mance as well. For example, via lobbying, a company could secure a
lower tax rate than it would otherwise pay and be able to borrow
funds more easily. This leads to our fifth hypothesis.
H5. Political connections have a positive effect on company
performance
Political relations play an important role in strengthening or
weakening the relationship of eco-innovation to performance and
the cost of equity capital. Lin et al. (2014) provided evidence that
political connections had a negative effect on green products and
innovation processes. Political connections can negatively affect
corporate governance via the inefficient allocation of resources.
Thus, these connections reduce green-innovation implementation.
In contrast, Zhang (2017) provided evidence that political connec-
tions had a positive effect on corporate environmental re-
sponsibility. A company’s political connections can provide
advantages in terms of accessing policy information, funds, tax
advantages, and subsidies. The contribution of political connections
will then strengthen the negative and positive impacts of eco-
innovation on the cost of equity capital and financial perfor-
mance, respectively.
H6. Political connections strengthen the negative association be-
tween eco-innovation and the cost of equity capital.
H7. Political connections strengthen the positive association be-
tween eco-innovation and company financial performance.
3. Research methodology
This study leverages secondary data using panel regression. Eco-
innovation data on variables, cost of equity, financial performance,
and political connections are taken from audited annual reports.
Eco-innovation data are also gathered from companies’ sustain-
ability reports and official corporate websites.
3.1. Operational definition of the primary variables
The cost of equity capital, a dependent variable in the first
model, is measured using the price-earnings growth (PEG) ratio
(Easton, 2004). This ratio combines prices, estimated earnings, and
profit growth, which can be used as the basis for stock recom-
mendations. It can also implicitly provide a comparison of expected
rates of return (Easton, 2004). At the calculation stage, a negative
ratio was removed from the study. The negative value was gener-
ated from the negative earnings per share from four consecutive
years and is considered invalid. Valid representations of this ratio
help lower measurement errors (Witmer and Zorn, 2007) and can
be used to estimate the highest capital costs better than other
estimation models (Lee, 2006). The cost of equity capital using the
PEG ratio is measured using Eq. (1).
sffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
EPStþ2  EPStþ1
CoC ¼ : (1)
P0
where:
CoC: cost of equity capital
EPStþ2: earnings per share at date t þ 2
EPStþ1: earnings per share at date t þ 1
P0: price per share at current date t ¼ 0
Eco-innovation is assessed using content analysis of related in-
formation disclosed by company websites, annual reports, and
sustainability reports. Previous studies measured eco-innovation
using a dummy variable (i.e., 1 for doing eco-innovation, 0 other-
wise) (Przychodzen and Przychodzen, 2015). This study leverages
scoring to measure eco-innovation, for which there are several
types: product, process, organization, and marketing. It is per-
formed as follows.
- It is given a value of 0 if the company does not have eco-
innovation types.
- It is given a value of 1 if the company carries out 1 of the 4 types.
- It is given a value of 2 if the company carries out 2 of the 4 types.
- It is given a value of 3 if the company carries out 3 of the 4 types.
- It is given a value of 4 if the company carries out all types.
Company performance, a dependent variable for the second
model, is measured using the return on assets (ROA), a measure-
ment of a company’s financial performance. It is used because it is a
more holistic performance indicator and measures corporate
profits as a representation of total assets (Lau, 2016). Then, the
variable is intended to reflect on how profitable companies can
have better investment opportunities. Following Przychodzen and
Przychodzen (2015), the ratio is computed as
EBIT
ROA ¼ : (2)
Total Asset
where:
ROA: return on assets
EBIT: earnings before interest and taxes
Political connections, an independent and a moderating vari-
able, can strengthen or weaken the impact of eco-innovation. It is
measured using dummy variables. It receives 1 if commissioners
and directors of companies get involved with government agencies,
and 0 otherwise. Political connection occurs when commissioners
or directors have been or are currently serving in government
agencies, military posts, or political parties (Zhang, 2017).
3.2. Research models
Two research models are used in this study. The first was tested
using a total of 1,100 observations, comprising 220 firms over a 5-
year period of research (2011e2015). The cost of equity capital is
 G. Latupeirissa, D. Adhariani / Journal of Cleaner Production 258 (2020) 120579
measured using the PEG ratio, which requires a t value þ 2,
requiring the data to be curtailed at 2015 for Model I. The second
model used a total of 1,398 observations, comprising 233 sample
companies over a 6-year period of research (2011e2016). The
research models are presented below.
3.2.1. Research Model I
The first model tests Hypotheses 1, 4, and 6, which discuss the
external economic impact of eco-innovation through the com-
pany’s cost of capital. A benefit obtained by companies from
implementing eco-innovation as part of their business strategy is
cost reduction. Kim et al. (2015) found that companies with lower
carbon risks have lower costs of equity capital. The cost of equity is
the focus of this research, as shareholders have a higher risk
compared with debt holders arising from fluctuations in share
prices. The first research model was tested using 1100 observations,
consisting of 220 companies and a five-year research period
(2011e2015). The research is limited to 2015 because in the
dependent variable, the cost of capital measured by the PEG ratio
requires the value of t þ 2, where 2017 is the most current data for
this research.
For Hypotheses 1 and 4
CoCit ¼ ait þ b1EcInit þ b2HubPolit þ b3levit þ b4Sizeit þ b5CsLit
þ b6Negit þ εit
For Hypothesis 6
CoCit ¼ ait þ b1EcInit þ b2HubPolit þ b3EcIn*HubPolit þ b4levit
þ b5Sizeit þ b6CsLit þ b7Negit þ εit
3.2.2. Research Model II
The second model tests Hypotheses 2, 3, 5, and 7, related to the
company’s internal economic impact of applying eco-innovation.
Przychodzen and Przychodzen (2015) empirically prove that com-
panies implementing eco-innovation demonstrate enhanced per-
formance and higher profitability. The total observations for this
model are 1398, with 233 company samples and a six-year research
period (2011e2016).
For Hypothesis 2 and Hypothesis 5
FirPerfit ¼ ait þ b1EcInit þ b2HubPolit þ b3Levit þ b4Sizeit
þ b5CsLit þ b6Negit þ εit
For Hypothesis 7
FirPerfit ¼ ait þ b1EcInit þ b2HubPolit þ b3EcIn*HubPolit
þ b4Levit þ b5Sizeit þ b6CsLit þ b7Negit þ εit
For Hypothesis 3
EcInit ¼ ait þ b1HubPolit þ b2Levit þ b3Sizeit þ b4Negit þ εit
CoC is the cost of equity capital as measured using the PEG ratio
(Easton, 2004). It is the roots of EPS, tþ2-EPS, tþ1, divided by the
share price of the current year. FirmPerf is the financial performance
measured using the ROA (EBIT/TA) (Przychodzen and Przychodzen,
2015). HubPol represents the political connections measured using
the dummy variable, 1, for companies with political links, and 0 for
those with none. EcIn is a judged score. Eco-innovation in this
research comprises several types of product innovation, processes,
organizations, and marketing. After examining the disclosure of
eco-innovation activities published by the company, we provided a
5
score from 0 to 4 based on the number of innovation types
performed.
Control variables used in the regression are: Lev represents the
leverage by total debt/TA. Size represents company size, measured
by the natural logarithm of total assets. CsL is the company’s life
cycle, measured by retained earnings divided by total assets. Neg is
negative net income, measured by a dummy. Negative net income
is given a value of 1, 0 for positive.
This study uses ordinary least square (OLS) statistical regression
for data analysis. To test the hypothesis, a regression with balanced
panel data is used for each research model. Before testing the hy-
pothesis, all classical assumptions are tested first. Panel data
regression was then conducted using the Chow and Hausman tests
to decide whether to use common effect, fixed effect, or random
effect.
4. Results
This study’s sample included companies listed on the IDX that
met several purposive sampling criteria, as follows. There were
1,100 observations for the first model and 1,398 observations for
the second.Table 1.
Before proceeding to the results of hypothesis testing, the
descriptive statistics are presented. As shown in Table 2, for
Research Model I, the dependent variable, cost of equity capital,
was measured using the PEG ratio, revealing an average of 9.46
with a standard deviation of 8.89. The average eco-innovation score
was 0.61, with a standard deviation of 0.80.
Table 3 shows the results of the descriptive statistics for Model
II, using financial performance, as measured by ROA. The average
ROA was 0.077, with a standard deviation of 0.147. This is low,
reflecting the general financial environment in Indonesia. The
average eco-innovation was 0.63, and its standard deviation was
0.79. Additionally, political connections as an independent variable
averaged 0.48. This indicates that 48% of companies from the
sample of 233 had political ties.
Detailed eco-innovation scores are presented in Table 4. The
data shows a decreasing trend in the number of companies not
engaging in eco-innovation initiatives, from 67% in 2011 to 44% in
2016. Most companies had one type of eco-innovation, mostly via
product or process. None had all four types.
4.1. Results of hypothesis testing
4.1.1. Research model I
Table 5 shows the results for Hypotheses 1 and 4. It can be seen
that Hypothesis 1 was not accepted. Thus, eco-innovation was not
found to affect the cost of equity capital. This could be because, in
Indonesia, investors are generally not aware of environmental is-
sues. This result differs from Kim et al. (2015), who found that firms’
Table 1
Research sample.
Number of companies listed on the IDX from 2011 to 2016 398
Less:
Delisting companies from 2011 to 2016 (18)
Incomplete annual reports (93)
Companies that posted in a mid-year of the research period (75)
Companies with negative EPS for 4 years straight (Model 1) (12)
Research sample for Research Model I 220
Research sample for Research Model II 233
Research period (2011e2015 for Research Model I) 5
Research period (2011e2016 for Research Model II) 6
Total Observations for Research Model I 1,100
Total Observations for Research Model II 1,398
6 G. Latupeirissa, D. Adhariani / Journal of Cleaner Production 258 (2020) 120579

Table 2 coefficient of 1.532. This indicates that the stronger a firm’s political
Descriptive Statistics. Model I. connections, the higher its cost of equity capital, which shows that
Mean Median Max Min Std Dev a company’s political connections are viewed as neither strength
CoC 9.4665 7.2459 66.6200 0.1270 8.8933
nor an advantage by investors. Although a company may have
EcIn 0.613 0 3 0 0.800 political connections, it does not lower its cost of equity capital.
HubPol 0.465 0 1 0 0.499 These results differ from those of previous studies, notably that of
Lev 0.254 0.218 4.976 0 0.320 Boubakri et al. (2012), who found that politically connected firms
Size 28.360 28.316 33.134 22.930 1.663
enjoyed lower equity capital costs compared with those with no
CsL 0.118 0.184 9.424 85.65 4.486
Neg 0.105 0 1 0 0.307 such connections.
CoC: cost of equity capital, EcIn: eco-innovation score, HubPol: political connections,
Lev: leverage, Size: company size, CsL: company life cycle, Neg: negative income. 4.1.2. Research model II
Results showed that companies with political connections
innovate more. The stronger the company’s connections, the
Table 3
greater the level of eco-innovation. This could be because com-
Descriptive Statistics. Model II.
panies with political connections have opportunities to obtain
Mean Median Max Min Std Dev more and bigger subsidies. Under Indonesia’s environmental reg-
ROA 0.077 0.0649 3.655 0.509 0.147 ulations, there is a provision requiring firms to manage their waste.
EcIn 0.637 0 4 0 0.797 They are forced to pay high fees for waste management in accor-
HubPol 0.481 0 1 0 0.499 dance with standards. This could be a reason companies with po-
Lev 0.289 0.232 4.976 0 0.417
Size 28.409 28.395 33.198 22.930 1.672
litical connections are more compliant. This finding supports
CsL 0.189 0.155 9.424 85.650 4.268 previous research by Tsai and Xu (2018), who found that companies
Neg 0.203 0 1 0 0.402 with strong political connections innovated more.Table 6.
RoA: return on assets, EcIn: eco-innovation score, HubPol: political connections, From Table 7, Hypothesis 2 was not accepted. It had a probability
Lev: Leverage, Size: company size, CsL: company life cycle, Neg: negative income. of 0.93 at a 10% significance level. This could be due to company
costs increasing to the point where they exceed income, resulting in
eco-innovation having no effect on financial performance. This
Table 4 supports the assertion by Nishitani et al. (2017), who said that
Eco-innovation scores. company environmental concerns were focused more on
- 0 if the company did not have eco-innovation of any kind.
- 1 if the company performed one of the four types of eco-innovation.
improving the environment than financial performance. Hojnik
- 2 if the company performed two of the four types of eco-innovation. and Ruzzier (2016) believed that eco-innovation only yielded
- 3 if the company performed three of the four types of eco-innovation. benefits for the environment by reducing the environmental
- 4 if the company performed all types of eco-innovation. impact of the company. However, it is the company that is obliged
Scores* Year to bear all of the costs. When considering eco-innovation, a com-
pany must have adequate resources and competent management,
2011 2012 2013 2014 2015 2016
both of which entail greater expenditure.
0 67% 59% 53% 51% 48% 44% Political connections have a positive effect on company financial
1 23% 27% 32% 32% 34% 38%
2 9% 12% 13% 15% 14% 14%
performance. Thus, Hypothesis 5 was accepted. The stronger the
3 1% 1% 2% 3% 4% 3% company’s political connections, the better its financial perfor-
4 0% 0% 0% 0% 0% 0% mance. This could be caused by better support from political con-
*Note. nections (Zhang, 2017).
The results shown in Table 8 suggest that political connections
moderately strengthen the positive relationship between eco-
Table 5 innovation and the cost of equity capital. The random-effect
Panel Data Regression Results. Hypotheses 1 and 4. H1: Eco-innovation has a model showed a probability of 0.085, less than the alpha of 0.10.
negative effect on the cost of equity capital. H4: Political connections have a
negative effect on the cost of equity capital.
Thus, Hypothesis 6 was rejected because it was expected that po-
litical connections would strengthen the negative association be-
CoC tween eco-innovation and the cost of equity capital. This highlights
Coeff. Prob. the previous findings wherein eco-innovation positively impacted
EcInov 0.08 0.79 the cost of equity capital, meaning that market players were not
HubPol 1.532 0.038 well-informed about a company’s eco-innovation efforts or did not
Lev 2.426 0.101 have enough trust to believe that such an effort would contribute to
Size 0.952 0.025
CsL 0.075 0.436
Neg 0.045 0.935 Table 6
R Square 0.89 Panel Data Regression Results. Hypothesis 3. H3: Political connections positively
CoC: cost of equity capital, EcIn: eco-innovation score, HubPol: political connec- affect eco-innovation.
tions, Lev: leverage, Size: company size, CsL: company life cycle, Neg: negative
Eco-innovation
income.
Coef Prob

HubPol 0.084 0.045

Lev 0.063 0.110
disclosures on reduced carbon risks resulted in lower equity capital Size 0.157 0.000
costs. Neg 0.034 0.167
For Hypothesis 4, Table 5 shows that political connections had a R Square 0.049
positive effect on the cost of equity capital. At the 10% significance HubPol: political connections, Lev: leverage, Size: company size, CsL: company
level, the probability of political connections was 0.038, with a life cycle, Neg: negative income.
 G. Latupeirissa, D. Adhariani / Journal of Cleaner Production 258 (2020) 120579 7

Table 7 the application of eco-innovation and the influence of political re-

Panel Data Regression Results. Hypotheses 2 and 5. H2: Eco-innovation has a posi- lationships wielded by the company to moderate influences.
tive effect on the company’s financial performance. H5: Political connections have a
positive effect on company performance.
Although the impact on financial performance has been investi-
gated in prior studies (Cheng et al. (2014); Przychodzen and
ROA Przychodzen (2015); and Ryszko (2016)), the impact on the cost
Coef Prob of equity and the role of political connections have not been widely
EcInov 0.0005 0.9349 investigated. Thus, these are original contributions of this research.
HubPol 0.0392 0.0045 Based on the content analysis of eco-innovation disclosed in the
Lev 0.3534 0.0000 corporate reports and official websites, it was found that there was
Size 0.0473 0.0000
an increasing trend of companies engaged from 2011 to 2016. Most
CsL 0.0040 0.0061
Neg 0.0923 0.0000 performed one type of eco-innovation. This implies that Indonesian
R Square 0.65 companies increased their attention to stakeholders’ interests, as
RoA: return on assets, EcIn: eco-innovation score, HubPol: political connections,
suggested by the stakeholder theory, by engaging in eco-innovation
Lev: leverage, Size: company size, CsL: company life cycle, Neg: negative income. as a specific sustainability initiative. The political connection was
the main variable found to be a significant determinant of eco-
innovation, representing the resources, as suggested by the
Table 8
Panel Data Regression Results. Hypothesis 6. H6: Political connections strengthen resource-based theory, available from the political ties that could
the association between eco-innovation and the cost of equity capital. be utilized to engage in eco-innovation.
The other results of the study demonstrated that a firm’s
CoC
application of eco-innovation did not affect its cost of equity capital
Coef Prob and financial performance. This might be attributed to the situa-
EcInov 0.669 0.141 tions in Indonesia where the environmental regulations are
HubPol 0.004 0.995 focusing more on the management of hazardous waste, making
EcInov * HubPol 0.931 0.085
other matters a minor concern. Additionally, there was limited in-
Lev 0.194 0.883
Size 1.598 0.000 formation in the companies’ voluntary disclosures, which could
CsL 0.036 0.686 have caused investors to miss the signal on environmental
Neg 0.148 0.780 improvement initiatives. Otherwise, in Indonesia, companies may
R Square 0.048
tend to only focus on improving their financial performance
CoC: cost of equity capital, EcIn: eco-innovation score, HubPol: political connections, without prioritizing the environment. This was evident from Model
Lev: leverage, Size: company size, CsL: company life cycle, Neg: negative income. II, where, from 233 companies, only 39% had implemented eco-
innovation, which could be related to the increase in costs borne
by firms compared with profits. Additionally, the government did
Table 9
Panel Data Regression Results. Hypothesis 7. H7: Political connections strengthen
not provide special assistance or incentives at the time.
the association between eco-innovation and company financial performance. This result differs from Kim et al. (2015), who found that com-
panies with a smaller carbon risk had a lower cost of equity capital.
ROA
This might be owing to the existence of mandatory government
Coef Prob regulations that require companies to achieve carbon emission
EcInov 0.002 0.849 reduction targets at a certain level in the countries being studied.
HubPol 0.036 0.033 However, this study only considers Indonesia, where environ-
EcInov * HubPol 0.004 0.734
mental preservation is only a rule; no mandatory requirements for
Lev 0.353 0.000
Size 0.047 0.000 companies to achieve a certain target in the improvement of their
CsL 0.005 0.006 environmental performance by means of eco-innovation exist.
Neg 0.092 0.000 However, this result supports the findings of Li et al. (2014), that is,
R Square 0.65 reducing carbon emissions does not affect the cost of equity capital.
RoA: return on assets, EcIn: eco-innovation score, HubPol: political connections, This is probably because the reduction in carbon emissions is still
Lev: leverage, Size: company size, CsL: company life cycle, Neg: negative income. relatively new and hence the market has not been able to react
sufficiently to environment-related information.
a company’s success regarding sustainability. The results of Table 9 This study also found that political connections positively
show that Hypothesis 7 was also not accepted, meaning that po- affected company financial performance. However, it also increased
litical connections did not affect the relationship between eco- the cost of equity, representing the lack of appreciation from capital
innovation and company financial performance. market players. Politically connected firms could be viewed as
To check the robustness of our results, we performed a sensi- having higher risks because the connections are not seen as a
tivity analysis by using the alternative measurement for the cost of source of corporate strength. The study found that political con-
equity capital and financial performance. Following Hajawiyah nections strengthened the eco-innovation relationships against
et al. (2019), we estimated the cost of equity capital using the equity capital costs, but they did not moderate the influence of eco-
CAPM model and used ROE (return on equity) to measure financial innovation on financial performance. The moderating effect of
performance (Przychodzen and Przychodzen, 2015). The results political connections on the association between eco-innovation
(un-tabulated) were consistent with the main tests, and we still and the cost of equity might hinder the direct positive benefits
could not find any impact of eco-innovation on the cost of equity on eco-innovation when there is no adequate channel to commu-
capital and financial performance in the Indonesia context. nicate the efforts to investors.

5. Discussion 6. Conclusion

This study aimed to determine the external impacts (cost of This study investigated the external and internal impacts of eco-
equity capital) and the internal impacts (financial performance) of innovation on the cost of equity capital and corporate financial
8 G. Latupeirissa, D. Adhariani / Journal of Cleaner Production 258 (2020) 120579
performance, as well as the moderating role of political connections
in Indonesia as an emerging market. The findings show that eco-
innovation does not have a significant impact, but political con-
nections do. Political connections are also found to influence eco-
innovation and strengthen its association with the cost of equity
capital.
The results of this study bring several implications. First, the
insignificant impact of eco-innovation on the cost of equity implies
that there should be adequate, readable, and understandable dis-
closures on firms’ initiatives so that investors can appreciate the
low cost of equity capital. Second, to convey the impact of eco-
innovation on financial performance, the government could
enhance eco-innovation by providing monetary incentives, such as
additional subsidies for continuous innovation to compensate for
the additional costs of eco-innovation, which require adequate in-
vestments in human resource capacity and technology. The results
of this study can be used as the basis for environment-related
regulations by the government. In the absence of monetary in-
centives, Indonesian companies might also try to implement low-
cost eco-innovation by conducting benchmarking with companies
that have already applied similar strategies. This will contribute
significantly to the eco-innovation effort, ultimately leading to
cleaner production methods and environmental sustainability.
Apart from the practical implications, this research also brings a
theoretical implication that bolsters the interest of academicians to
conduct more research on the impact of eco-innovation, given the
relative lack of similar studies in Indonesia. We focused on litera-
ture regarding the association between political connections and
eco-innovation, considering that political connections is one type
of company-related capital from the resource-based theory
perspective that articulates the importance of optimally employing
capital to encourage eco-innovation initiatives in Indonesia. As
stated by Whetten (1989), a legitimate contribution to theory
development primarily comes from the explanation of the rela-
tionship between variables owing to changes in specific variables
(additions or deletions from the research model). By adding the
political connections variable, we extend the literature by showing
that in the Indonesian context, political connections have a direct
positive impact on eco-innovation; however, the connections have
not yet been utilized optimally to provide investors with “trust” in a
company’s eco-innovation initiatives. This might be owing to the
investors’ difficulties in understanding the company’s disclosures
regarding eco-innovation initiatives, or because the disclosures
themselves are not adequate to ensure transparency, hence
resulting in a higher cost of equity capital.
This study has a number of limitations. The small number of
years is insufficient to describe the overall impact of the imple-
mentation of eco-innovation on either the cost of equity capital or
company performance. Thus, further research should look to in-
crease the number of years included in the period of study. Addi-
tionally, the measurement of financial performance was conducted
using only ratios. Hence, it could not capture the full performance
of the firm. Future research should thus add a measure of company
performance, based on both accounting and market size. The
measurement of eco-innovation was based only on secondary data
in the form of written information issued by the companies (e.g.,
annual reports and official websites), meaning that the eco-
initiative implementation was based only on information the
company chose to provide. Furthermore, it should apply observa-
tions and questionnaires focusing on one industry or company. In
this study, political relations were looked at holistically. In practice,
however, a company’s political relationships arise from different
agencies. Certain types of extant political relationships in the
business sector have big impacts. Future research can also inves-
tigate the moderating role of eco-innovation on the association
between political connections and the cost of capital and financial
performance.
Declaration of competing interest
None.
CRediT authorship contribution statement
Gracezelda Latupeirissa: Writing - original draft, Conceptuali-
zation. Desi Adhariani: Writing - review & editing,
Conceptualization.
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