Journal of Business Research 65 (2012) 1636–1642

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Journal of Business Research

Does going green pay off in the long run?

Chin-Chen Chien a, Chih-Wei Peng b,⁎
a
Department of Accountancy, National Cheng Kung University, 701, Taiwan
b
Department of Accounting and Information, Asia University, 413, Taiwan

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

Article history: This study uses mandatory disclosures of environmental expenditures for public companies in Taiwan, to
Received 1 March 2011 examine the impact of investment in pollution control on long-run financial performance. We break
Received in revised form 1 July 2011 down pollution control investments into the following two categories by analyzing the content of the dis-
Accepted 1 October 2011
closures made in annual reports: (1) pollution prevention and (2) end-of-pipe solutions. Based on a sample
Available online 24 October 2011
of five major polluting industries in Taiwan from 1989 to 2006, we find that firms moving forward proac-
Keywords:
tively with pollution prevention investments have significantly outperformed their counterparts who
Pollution control investment react sluggishly with end-of-pipe solutions. In addition to the notion that environmental expenditures are not
Pollution prevention investment necessarily detrimental to firms, our results also suggest that the often conflicting goals of financial reporting,
End-of-pipe pollution control investment namely representational faithfulness and macroeconomic growth, may be harmonized if the accounting standards
Long-run financial performance embody the different features of pollution control investments.
Voluntary overcompliance © 2011 Elsevier Inc. All rights reserved.

1. Introduction
Researchers have extensively examined the relation between fi-
nancial performance and pollution control investment, although the
results have been inconclusive. In his seminal study, Spicer (1978)
finds that firms with better pollution control records tend to have
higher profitability, lower systematic risk, and higher price to earn-
ings ratios than firms with poorer pollution control. However, various
studies have drawn the opposite conclusions, such as Chen and Metcalf
(1980), Smith and Sims (1985), Jaggi and Freedman (1992), Mathur
and Mathur (2000), Judge and Elenkov (2005). The collective evidence
from these studies suggests that investing in pollution control activities
results in lower overall profitability, because it diverts resources to a
fundamentally non-productive use. More recent studies have generally
found a positive association between better pollution control and
higher financial performance (Al-Tuwaijri, Christensen, & Hughes,
2004; Brammer, Pavelin, & Porter, 2006; Clemens, 2006; Clemens &
Dougla, 2006; Dowell, Hart, & Yeung, 2000; and Menguc & Ozanne,
2005).
One explanation for these mixed results is that prior research has
not identified the effects of different kinds of pollution control invest-
ments. Pollution can be prevented either at the end-of-pipe, by cap-
turing pollutants for disposal, or during the production process with
upgraded facilities (Russo & Fouts, 1997). End-of-pipe solutions rely
on external recycling and recovery of waste, and are typically applied
after the production of goods or materials. This is the traditional
⁎ Corresponding author.
E-mail address: chihwei@asia.edu.tw (C.-W. Peng).
approach, and one that has often been implemented by corporations
in response to mandatory regulations. In contrast, pollution prevention
processes are a relatively more recent phenomenon (Boer, Curtin, &
Hoyt, 1998), and include (1) reducing waste and pollutants by modify-
ing production systems, equipment and operations, (2) using different
raw materials, (3) redesigning or reformulating products, and (4)
using in-process recycling (Oldenburg, 1987).
While it is clear that the costs incurred for end-of-pipe solutions
eventually become a drag on financial performance, many multina-
tional corporations (MNCs) claim that pollution prevention technolo-
gies may not only be less costly than end-of-pipe treatments, but in
some cases may enhance financial performance. As a result, MNCs
now have a tendency to move away from end-of-pipe approaches
and toward pollution prevention systems.
Environmental protection has risen dramatically as a public con-
cern in many countries, and Taiwan, like many other newly developed
nations, has considerable problems with pollution. In order to balance
the need for both economic growth and environmental protection, the
Taiwanese government enacted the Statute for Upgrading Industries in
1991. This statute not only contains very strict environmental protection
policies, but also provides tax incentives for pollution control invest-
ments. Additionally, the Taiwanese Financial Supervisory Commission
also requires publicly listed firms to disclose their environmental capital
expenditure in their annual reports.
We utilize the unique disclosure requirements stipulated by the
Taiwanese authorities to investigate the association between invest-
ments in pollution control and long-run financial performance. To our
knowledge, Sarkis and Cordeiro (2001) are the first to explore possible
performance differences between pollution prevention and end-of-pipe
approaches with regard to short-run financial performance, although

0148-2963/$ – see front matter © 2011 Elsevier Inc. All rights reserved.
doi:10.1016/j.jbusres.2011.10.023
 C.-C. Chien, C.-W. Peng / Journal of Business Research 65 (2012) 1636–1642
they are unable to examine the long-run relation due to data availability
limitations. However, they propose that a solution to this problem is to
use data envelopment analysis (DEA) models to estimate both the pol-
lution prevention and end-of-pipe ratios. Their empirical results, based
on DEA, indicate that pollution prevention and end-of-pipe strategies
are both negatively related to return on sales (ROS), and that this nega-
tive relation is larger and more significant for pollution prevention
strategies.
The availability of more data allows us to refine Sarkis and Cordeiro's
(2001) work in two respects. First, we manually collect the related data
to overcome the measurement errors that are associated with DEA
models. Second, we switch from the focus on short-term performance
to a longer time frame (up to five years).
Our sample includes five highly polluting industries: cement, plas-
tics, chemicals, paper and pulp, and iron and steel. The results indicate
that: (1) firms tend to invest in pollution control facilities in prosperous
years; (2) the investment in pollution control facilities is negatively as-
sociated with short- but not long-run financial performance; (3) the in-
vestment in end-of-pipe pollution control measures is negatively
associated with short-run performance; and, most importantly, (4) a
significant difference in both short- and long-run performance between
firms investing in pollution prevention and end-of-pipe pollution con-
trol measures.
In order to safeguard the external validity of using Taiwanese data,
we compare U.S. GAAP, IFRS and Taiwanese standards and find that
only U.S. GAAP (Emerging Issues Task Force (EITF) Issue No. 90–8
and EITF Issue No. 89–13) specifically requires the capitalization of
environmental expenditures due to the long-lived nature of pollution
control facilities, whereas both Taiwanese standards and IFRS have no
special requirements in this regard. In Taiwan, firms usually capitalize
their environmental capital expenditures due to the durability of pol-
lution control equipment (based on Taiwanese Accounting Standard
No. 1), which is consistent with IFRS (IAS 16). We also compare the
definitions of assets, stipulated in Taiwanese Accounting Standard
No. 1, the Framework for the Preparation and Presentation of Financial
Statements of IFRS, and the U.S. Statement of Financial Accounting Con-
cepts No. 6. We find a similarity among these standards, in that all re-
quire the expenditures to be recognized as assets only if they have
future economic benefits to the entity. It is thus clear that there is no
discrepancy in accounting practices in dealing with the capitalization
of environmental expenditures among these three sets of standards.
Consequently, we believe that the use of Taiwanese data does not ad-
versely affect the external validity, and there is no reason to assume
that our results cannot be generalized to other countries.
The major contribution of this research is its finding that the im-
pact of pollution control investment on financial performance is far
more complicated than previous research has suggested. Our results
have economic implications for management, governments, and the
bodies that set accounting standards. First, although pollution pre-
vention measures impose costs, managers should realize that they
also improve productivity. Consequently, a strategy of overcompliance
results in a win–win situation for both businesses and society as a
whole. Second, governments can provide different tax credits for in-
vestments that mitigate and prevent pollution. Specifically, they can en-
courage firms to upgrade their production facilities instead of wasting
their economic resources. Finally, we suggest that only investments in
pollution prevention should be capitalized, because of their positive
long-run effects on financial performance. In contrast, investments in
end-of-pipe pollution control should be expensed per se. If accounting
standard-setting bodies integrate the implications of our empirical find-
ings then managers may be encouraged to upgrade production facilities
with the twin aims of greater efficiency and producing less pollution. An
amended accounting standard based on the implications of our findings
would produce a significant outcome of harmonizing some of the gen-
erally conflicting objectives of financial reporting, namely, representa-
tional faithfulness and macroeconomic growth. For example, the
1637
economic consequences of accounting standards cannot be overlooked,
as evidenced by the impact of R&D accounting on U.S. global competi-
tion during the 1980s and the reclassification of financial assets under
IFRS in the 2008 financial crisis.
The rest of this paper is organized as follows. Section 2 presents the
research issues. Section 3 describes the research method. Section 4 pre-
sents the empirical results, and Section 5 concludes this study with rec-
ommendations for managers and suggestions for future research.
2. Background and research questions
Two theories compete in the literature with regard to the associa-
tion between pollution control investment and financial performance.
Traditional economic theory asserts that investing in pollution control
activities results in lower overall profitability by diverting economic re-
sources to a fundamentally non-productive use (Chen & Metcalf, 1980;
Jaggi & Freedman, 1992; Judge & Elenkov, 2005; Mathur & Mathur,
2000; Smith & Sims, 1985). In contrast, the overcompliance theory sug-
gests that economic benefits can arise from better pollution control in-
vestment (Arora & Gangopadhyay, 1995; King & Lenox, 2001; Porter &
van der Linde, 1995; Salop & Scheffman, 1987). We believe that dividing
investment activities into prevention and end-of-pipe solutions is able
to better distinguish between the two theories.
It is evident that traditional economic theory applies most directly to
end-of-pipe pollution control investments, which usually entail expen-
sive, non-productive equipment to achieve compliance with existing
environmental regulations. Such investments are seen to be detrimen-
tal to firm performance, because they incur costs and utilize resources
for non-productive activities in order to comply with regulatory stan-
dards for controlling pollution and protecting public health (Hart,
1995; Russo & Fouts, 1997; Sarkis & Cordeiro, 2001). However, support
is growing for the overcompliance theory, as evidenced by the many
MNCs that have successfully implemented pollution prevention mea-
sures, such as 3M's Pollution Prevention Pays (PPP) and Dow's Waste
Reduction Always Pays (WRAP) programs, which have produced sub-
stantial cost savings (Hart, 1995).
However, a common feature of prior studies is that they do not dis-
tinguish whether a specific pollution control investment is intended to
replace obsolete facilities or equipment or to alleviate end-of-pipe prob-
lems. We thus extend this line of research by examining the impact of
these two approaches to pollution control and their effects on financial
performance by utilizing the pollution control investment disclosures
requested by Taiwanese authorities. These disclosures allow us to iden-
tify whether the pollution control investment is for end-of-pipe or pre-
vention purposes, and we can examine whether the two approaches
have different impacts on long-run financial performance. We also de-
velop an appropriate statistical method that applies factor analysis to
integrate different financial performance measures into a single index
to prevent conflicting results arising from different accounting indica-
tors, such as return on assets (ROA), return on equity (ROE), earnings
per share (EPS), and cash flows to assets (CFA), which have all been
used in prior research to measure financial performance.
Based on the research topic, we investigate two questions: (1) is
the impact of pollution control investment on financial performance
significant? More importantly, (2) is the impact of pollution preven-
tion solutions on financial performance significantly different from
that of end-of-pipe solutions in the long-run? The first issue has
been examined extensively in the literature, although with mixed re-
sults, and we believe our research methods and data set resolve the
apparent contradictions in the previous work. However, the second
issue, to the best of our knowledge, has only been investigated by Sarkis
and Cordeiro (2001). Due to the limitations of data availability, they em-
ploy a two-stage approach of (1) calculating DEA efficiency scores, and
(2) using these scores as dependent variables for a multiple regression
model that incorporates firm characteristics and performance. They
find a negative association between environmental performance and
1638 C.-C. Chien, C.-W. Peng / Journal of Business Research 65 (2012) 1636–1642
short-term financial performance, and that pollution prevention is
more negatively associated with short-term performance than end-
of-pipe investment. However, they also provide certain caveats about
the measurement problem of employing DEA, and broach the intriguing
subject of extending this line of research to a longer-term (five-year)
horizon. Therefore, we provide a direct extension of their pioneering
work in this area.
3. Research method
3.1. Sample information
Our sample includes firms in five highly polluting industries: ce-
ment, plastics, chemicals, paper and pulp, and iron and steel. We obtain
the financial variables and market value data from Taiwan's SFI (Securi-
ties and Futures Institute) database and the Taiwan Economic Journal
(TEJ) database for the period 1989–2006, and manually collect the envi-
ronmental capital expenditure information, such as the date, amount,
purposes, and the expected benefits of each pollution control invest-
ment from annual financial reports.
We categorize the investments into pollution prevention and end-
of-pipe pollution control according to the information disclosed in the
annual reports. We apply the principle of proportionality to classify a
firm into one of these two categories in years it made both types of in-
vestments. In the end, we have 106 observations for firms with pollution
prevention investments, and 53 for firms with end-of-pipe pollution con-
trol investments. Overall, the sample suggests that firms tend to over-
comply with the environmental protection regulations. The Appendix de-
tails our classification procedures. In robustness tests, we exclude those
firms that made both types of investment from our sample to avoid
ambiguities.
3.2. Empirical model
We follow Jaggi and Freedman (1992) in measuring financial per-
formance using four accounting indicators, namely, return on assets
(ROA), return on equity (ROE), earnings per share (EPS), and cash
flows to total assets (CFA). However, unlike many studies that use in-
dividual indicators to measure performance, we perform factor anal-
ysis with Varimax rotation to identify the factor patterns.
The factor analysis model can be stated as follows.
Yi ¼ μ þ Lfi þ εi ; i ¼ 1; 2; …; n;
where Yi is a set of p observable random variables, (f1, f2,.., fn) are the
factor scores for each observation and the L's are unobservable factor
loadings.
We wish to find the vector of common factors for subject i, or f^i , by
minimizing the sum of the squared residuals. In matrix notation the
solution is expressed as:
0
−1 0
f^i ¼ L L L ðYi −μ Þ:
We substitute our estimated factor loadings into this expression as
well as the sample mean for the data, as follows:
 −1
f^i ¼ L^ L^ L^ ðYi −y Þ:
0 0
The factor score is a standardized number with a mean of zero and
a standard error of one. The factor analysis yields only one factor
(with an eigenvalue greater than one) that captures the commonality
among these four variables, and its factor score essentially represents
an index that integrates these four performance measures.
We then follow the approach of Megginson, Nash, and Van Ran-
denborgh (1994), who compare the short- and long-run financial
performances of the matched samples. We use a three-year window
(from one year preceding the investment to one year subsequent to
it) to measure the short-term performance, while a seven-year window
(three years before through three years after the investment) and an
eleven-year window (five years before through five years after) to mea-
sure the long-run performance. We then calculate the average factor
score for each firm over the pre- and post-investment windows. More
specifically, for the seven-year window, we calculate two sets of the aver-
age factor scores, that is pre-investment: years −3 to −1 and post-
investment: years +1 to +3. The same procedure also applies to the
eleven-year window.
We then apply the conventional t-test, the nonparametric test and
multiple regression models to examine possible long-run impacts of
pollution control investment on financial performance under various
scenarios. It is also worth noting that the windows we use to measure
long-run performance are those that are commonly adopted in the
literature (for example, Carter, Dark, & Singh, 1998, among others.;
Loughran & Ritter, 1995)
The multiple regression model is specified as follows:
Perf ormancei ¼ β0 þ β1 Prevent þ β2 MTB þ β3 Size þ β4 Beta þ ε ð4Þ
We perform factor analysis to generate factor scores from four ac-
counting variables (ROE, ROA, EPS and CFA). We then follow the ap-
proach proposed by Megginson et al. (1994) to measure financial
performance with three different windows. Let Year(t) be the year
of investment, Performance0 then denotes the difference in a firm's
factor score between Year(t + 1) and Year(t − 1), Performance1 de-
notes the difference in the average factor score of Year(t + 1) to
Year(t + 3) and Year(t − 3) to Year(t − 1), and Performance2 denotes
the difference in the average factor score of Year(t + 1) to
Year(t + 5) and Year(t − 5) to Year(t − 1). Prevent is an indicator var-
iable that is set to a numerical value of 1 for firms with pollution pre-
vention investments, and 0 for firms with end-of-pipe pollution
control investments. MTB denotes the ratio of the market value of eq-
uity to the book value of equity. Size denotes the natural logarithm of
total assets. The last independent variable, Beta, denotes the systematic
risk and is obtained from running the regression of the market model.
Table 1 summarizes the definitions of the key variables employed in
this study.
Earlier studies generally used market-to-book ratio, firm size, and
unexpected earnings as control variables (Al-Tuwaijri et al., 2004;
ð1Þ Sarkis & Cordeiro, 2001.) Following Fama and French (1992), we re-
place unexpected earnings with Beta because (1) unexpected earnings
has been consistently insignificant in these earlier studies, and (2) the
Fama-French model has drawn much attention with regard to the
issue of anomalies in returns. A wealth of research also suggests that fi-
nancial performance can be measured by accounting variables as well as
stock returns, which further justifies using the Fama-French variables.
4. Empirical results
ð2Þ
Table 2 reports descriptive statistics for the variables used in this
study. The means of Performance0, Performance1 and Performance2
are 0.11, −0.03, −0.02, respectively. The mean of Pollution (indicator
variable) is 0.22, suggesting that about 22% of sample firms mention
pollution control investment disclosures in their annual reports. The
ð3Þ
mean of Prevent is 0.67, suggesting that the majority of the pollution
control investments are for prevention purposes. The means of MTB,
Size, and Beta are 1.43, 15.62, and 0.75, respectively.
Table 3 presents univariate comparisons of financial performance
of firms with pollution control investments and those who do not
have pollution control investments in different subperiods. The first
three rows indicate no significant differences in financial perfor-
mance between these two groups before they make pollution control
investments. However, we find that mean and median Fsc(t) are
 C.-C. Chien, C.-W. Peng / Journal of Business Research 65 (2012) 1636–1642 1639

Table 1 those with end-of-pipe pollution control investments. While we find

Definition of variables. no significant differences in financial performance between these two
Variables Definition groups of firms during the pre-investment period, the end-of-pipe pol-
lution control investments appear to hinder the mean financial perfor-
Dependent variables
Performance0 We perform factor analysis to generate factor scores from four mance more drastically than the pollution prevention investments at
Performance1 accounting variables (ROE, ROA, EPS and CFA). We then follow the T = 1 (Fsc(t) is −0.63 vs. −0.05 with a t-statistic of 2.35, which is signif-
Performance2 approach proposed by Megginson et al. (1994) to measure financial icant at a five-percent confidence level).
performance with three different windows. Let Year(t) be the year of
Table 4 further indicates that the mean differences in Performance0
investment, Performance0 then denotes the difference in a firm's
factor score between Year(t + 1) and Year(t − 1), Performance1 and Performance1 between these two groups are both significant at a
denotes the difference in the average factor score of Year(t + 1) to five-percent confidence level (0.02 vs. −0.69 with a t-statistic of 2.26,
Year(t + 3) and Year(t − 3) to Year(t − 1), and Performance2 denotes and 0.14 vs. −0.16 with a t-statistic of 2.05). The preliminary results
the difference in the average factor score of Year(t + 1) to Year(t + 5) are consistent with our postulation that firms that make investments
and Year(t − 5) to Year(t − 1).
in pollution prevention significantly outperform those that make in-
Independent variables vestments in end-of-pipe pollution control.
Pollution Pollution is an indicator variable that is set to a numerical value of 1 Table 5 reports the empirical results of Eq. (4) investigating the as-
for firms with pollution control investments, and 0 for otherwise. sociation between future performance and investment type. Specifi-
Prevent Prevent is an indicator variable that is set to a numerical value of 1
cally, Eq. (4) regresses the dependent variables Performance1 and
for firms with pollution prevention investments and 0 for firms
with end-of-pipe pollution control investments. Performance2 on Prevent, MTB, Size and Beta, respectively. Prevent is
MTB MTB is the ratio of a firm's market value of equity to its book value an indicator variable that is set to a numerical value of 1 for firms
of equity. with pollution prevention investments, and 0 for firms with end-of-
Size Size is the natural logarithm of a firm's total assets. pipe pollution control investments. Panel A of Table 5 indicates that
Beta Beta is estimated by running an OLS regression of individual stock
the coefficients of Prevent are 0.35 and 0.27, with a t-statistic of 2.56
returns on market returns.
Prior1 Prior1 is the difference in factor scores between the investment year and 2.07, and these are significant at one-percent and five-percent
and Avg(− 3,−1). confidence levels, respectively. The results suggest that pollution pre-
Prior2 Prior2 is the difference in factor scores between the investment year vention investment is more positively associated with long-run finan-
and Avg(− 5,−1).
cial performance than end-of-pipe pollution control investments.
Our next research question examines whether pre-investment
performance affects post-investment performance. More specifically,
it is open to question whether firms with better pre-investment per-
significantly higher for firms with pollution control investments than formance tend to overcomply with the regulations. To investigate this
those who do not have pollution control investments at T = 0 (0.21 vs. in more detail, we include a pre-investment financial performance
−0.12 with a t-statistic of 3.90, and 0.08 vs −0.17 with a z-statistic of variable (Prior1 or Prior2) in the regression models as control vari-
4.24.) Both the t-statistic and Wilcoxon rank-sum z-statistic are signifi- ables. Prior1 denotes the difference in factor scores between the in-
cant at a one-percent confidence level. The results suggest that firms vestment year and Avg(−3,−1), and Prior2 denotes the difference
tend to make pollution control investments in periods in which they ex- in factor scores between the investment year and Avg(−5,−1).
perience better economic performance. Nevertheless, we also find that Panel B of Table 5 indicates that the coefficients of Prevent for
mean Fsc(t + 1) is significantly lower for firms with pollution control in- Performance1 and Performance2 are 0.33 and 0.25, with a t-statistic
vestments than those who do not have pollution control investments at of 2.65 and 2.16, respectively. The former is significant at a one per-
T = 1 (−0.24 vs 0.05 with a t-statistic of −2.80.) The results suggest cent confidence level, while the later is significant a five percent con-
that pollution control investments may drag down financial perfor- fidence level. The results are consistent with Panel A.
mance in the subsequent period. The mean and median Performance0
are significantly lower for firms with pollution control investments 5. Robustness tests
than those who do not have pollution control investments (−0.22 vs.
0.19 with a t-statistic of −2.89, which is significant at a one-percent We further conduct robustness tests to enhance internal validity.
confidence level, and −0.10 vs. 0.12 with a z-statistic of −2.04, which Firstly, we employ Tobin's Q as an alternative financial performance
is significant at a five-percent confidence level). The results are consis- measure, because it reflects the market's expectation regarding the
tent with Chen and Metcalf (1980), Smith and Sims (1985), Jaggi and cash flows that a firm's asset can generate (Amit & Wernerfelt,
Freedman (1992), and others, in that pollution control investment has 1990). We exclude Tobin's Q from the factor analysis because it is dif-
a negative short-run impact on financial performance. ferent from the four other accounting variables in nature. More spe-
Table 4 reports the empirical results of a more intriguing compari- cifically, ROA, ROE, EPS, and cash flows to total assets (CFA) are
son. Specifically, Table 4 compares the financial performance of firms reported in financial statements, while Tobin's Q is a number that
with pollution prevention investments to the financial performance of can be estimated using different models. Panel A of Table 6 indicates
that Prevent has a significant positive effect on Tobin's Q (coeffi-
cient = 0.40, p b 0.05), which is consistent with the previous findings.
Secondly, we exclude firms that have made both pollution preven-
Table 2
Descriptive statistics.
tion and end-of-pipe pollution control investments, without applying
the proportionality principle, in order to lessen the confounding ef-
Variable N Mean Std. dev. Minimum Maximum fect. Panel B of Table 6 indicates that the coefficients of Prevent1 are
Performance0 717 0.11 1.32 − 8.43 5.58 0.49 and 0.32, which are significant at the one-percent and five-
Performance1 671 − 0.03 0.88 − 3.14 3.26 percent confidence levels, respectively.
Performance2 596 − 0.02 0.75 − 3.06 2.16
Finally, we use stock return as a proxy for financial performance.
Pollution 717 0.22 0.42 0 1
Prevent 159 0.67 0.47 0 1 Panel C of Table 6 indicates that the coefficient of Prevent for Return1
MTB 717 1.43 1.01 0.07 9.20 (3 years) is 0.63, which is significant at a five-percent confidence
Size 717 15.62 1.12 13.20 19.55 level. However, the coefficient of Prevent for Return2 (5 years) is
Beta 717 0.75 0.31 − 0.45 1.57 0.82, which is only significant at a ten-percent confidence level. Al-
Note: definitions of the variables appear in Table 1. though using stock return as a proxy for financial performance lowers
1640 C.-C. Chien, C.-W. Peng / Journal of Business Research 65 (2012) 1636–1642

Table 3
Comparison of the financial performance between firms with/without pollution control investments.

Pollution control investments Significance tests of the

difference
Firms have pollution control Firms do not have pollution control
investments investments

Period N Mean Median N Mean Median t-statistic z-statistic

Avg(− 5,−1) 136 − 0.09 − 0.12 460 − 0.01 − 0.05 − 1.75 − 1.37
Avg(− 3,−1) 150 − 0.01 − 0.02 521 − 0.02 − 0.04 0.34 0.21
Fsc(t − 1) 159 − 0.02 − 0.08 558 − 0.14 − 0.17 1.23 1.55
Fsc(t) 159 0.21 0.08 558 − 0.12 − 0.17 3.90⁎⁎ 4.24⁎⁎
Fsc(t + 1) 159 − 0.24 − 0.12 558 0.05 − 0.06 − 2.80⁎⁎ − 0.61
Avg(+ 1,+3) 150 0.02 0.05 521 − 0.06 − 0.09 1.47 2.24⁎
Avg(+ 1,+5) 136 − 0.01 − 0.04 460 − 0.05 − 0.09 0.75 0.97
Performance0 159 − 0.22 − 0.10 558 0.19 0.12 − 2.89⁎⁎ − 2.04⁎
Performance1 150 0.03 0.04 521 − 0.04 − 0.08 0.85 1.32
Performance2 136 0.08 0.03 460 − 0.04 − 0.01 1.68 0.39

Note: 1. Let Year(t) be the year of investment. Avg(− 5,−1) denotes the average factor score of Year(t − 5) to Year(t − 1). Avg(− 3,−1) denotes the average factor score of Year(t − 3)
to Year (t − 1). Fsc(t − 1) denotes the factor score 1 year before the investment. Fsc(t) denotes the factor score in the year of investment. Fsc(t + 1) denotes the factor score 1 year
subsequent to the investment. Avg(+ 1,+3) denotes the average factor score from Year(t + 1) to Year(t + 3). Avg(+ 1,+5) denotes the average factor score from Year(t + 1) to
Year(t + 5). Performance0 then denotes the difference in a firm's factor score between Year(t + 1) and Year(t − 1), Performance1 denotes the difference in the average factor score
of Year(t + 1) to Year(t + 3) and Year(t − 3) to Year(t − 1), and Performance2 denotes the difference in the average factor score of Year(t + 1) to Year(t + 5) and Year(t − 5) to
Year(t − 1).
2. We use Satterthwaite t-statistics to test the means for unequal variances, and the pooled t-test otherwise.
3. The Wilcoxon rank sum test (z-statistic) is used to examine the statistical significance level of the differences between two medians.
4. ⁎⁎ and ⁎ represent significance at the 1% and 5% levels with the two-tailed test, respectively.

the significance of the difference, the results still suggest that over-
compliance with regulations is the best strategy for firms to adopt.
6. Conclusions
The relation between pollution control investment and a firm's fi-
nancial performance is a complex issue, one that has been examined ex-
tensively for several decades with conflicting results. We exploit the
mandatory disclosure of pollution control investments made by the
public listed companies in Taiwan to further explore this intriguing
issue. The results suggest that pollution control investments, taken as
a whole, decrease short-run financial performance. However, we find
that this poor short-run financial performance is largely caused by the
end-of-pipe pollution control investments, and this suggests that man-
agers should avoid adopting only such solutions.
Our results also indicate that pollution prevention investment is pos-
itively associated with long-run financial performance, which suggests
that pollution prevention investment can not only lower a firm's nega-
tive environmental impacts, but can also improve its bottom-line in-
come by triggering innovations and ultimately lowering the costs of
compliance. Accordingly, firms should be aware that paying attention
to environmental concerns not only benefits the wider society, but
also strengthens their own financial performance. Since our research in-
dicates that pollution prevention measures have economic as well as en-
vironmental advantages over more conventional end-of-pipe solutions,
it is perhaps not surprising that they have been warmly received in
many newly developing countries.

Table 4
Comparison of the financial performance between firms with pollution prevention investments and firms with end-of-pipe pollution control investments.

Pollution control investments Significance tests of the

difference
Pollution prevention investments End-of-pipe pollution control investments

Period N Mean Median N Mean Median t-statistic z-statistic

Avg(− 5,−1) 88 − 0.14 − 0.14 48 − 0.01 − 0.01 − 1.48 − 1.79
Avg(− 3,−1) 95 − 0.06 − 0.08 55 0.09 0.01 − 1.50 − 1.52
Fsc(t − 1) 106 − 0.07 − 0.09 53 0.06 0.08 − 0.71 − 0.89
Fsc(t) 106 0.13 0.05 53 0.35 0.35 − 1.34 − 1.57
Fsc(t + 1) 106 − 0.05 − 0.06 53 − 0.63 − 0.16 2.35⁎ 0.78
Avg(+ 1,+3) 95 0.08 0.07 55 − 0.07 − 0.01 1.26 0.84
Avg(+ 1,+5) 88 0.02 − 0.01 48 − 0.08 − 0.07 1.22 0.36
Performance0 106 0.02 − 0.05 53 − 0.69 − 0.24 2.26⁎ 1.12
Performance1 95 0.14 0.20 55 − 0.16 − 0.10 2.05⁎ 1.52
Performance2 88 0.16 0.08 48 − 0.07 − 0.15 1.78 1.79

Note: 1. Let Year(t) be the year of investment. Avg(−5,−1) denotes the average factor score of Year(t− 5) to Year(t− 1). Avg(−3,−1) denotes the average factor score of Year(t − 3) to Year
(t− 1). Fsc(t − 1) denotes the factor score one year before the investment. Fsc(t) denotes the factor score in the year of investment. Fsc(t +1) denotes the factor score one year subsequent to
the investment. Avg(+1,+3) denotes the average factor score from Year(t +1) to Year(t+ 3). Avg(+1,+5) denotes the average factor score from Year(t+ 1) to Year(t + 5). Performance0
then denotes the difference in a firm's factor score between Year(t+ 1) and Year(t− 1), Performance1 denotes the difference in the average factor score of Year(t+ 1) to Year(t + 3) and
Year(t− 3) to Year(t −1), and Performance2 denotes the difference in the average factor score of Year(t+ 1) to Year(t+ 5) and Year(t − 5) to Year(t− 1).
2. We use Satterthwaite t-statistics to test the means for unequal variances, and the pooled t-test otherwise.
3. The Wilcoxon rank sum test (z-statistic) is used to examine the statistical significance level of the differences between two medians.
4. ⁎⁎ and ⁎ represent significance at the 1% and 5% levels with the two-tailed test, respectively.
 C.-C. Chien, C.-W. Peng / Journal of Business Research 65 (2012) 1636–1642 1641

Table 5
Regressions of long-run financial performance.

Panel A: regressions of long-run financial performance with control variables

Dependent variable: Performance1 (N = 150) Dependent variable: Performance2 (N = 136)

Independent variables Parameter estimates t-value p-value Independent variables Parameter estimates t-value p-value

Intercept −3.27⁎⁎ −3.39 b 0.01 Intercept −2.23⁎ −2.35 0.02

Prevent 0.35⁎⁎ 2.56 0.01 Prevent 0.27⁎ 2.07 0.04
MTB −0.18⁎⁎ −2.61 0.01 MTB −0.15⁎⁎ −2.22 0.03
Size 0.21⁎⁎ 3.42 b 0.01 Size 0.15⁎⁎ 2.48 0.01
Beta 0.21 1.01 0.31 Beta 0.08 0.41 0.68
F-statistic (p-value) 6.75 (p b 0.01) F-statistic (p-value) 4.02 (p b 0.01)
Adjusted R2 0.14 Adjusted R2 0.08

Panel B: regressions of long-run financial performance with pre-investment windows financial performance variable
Dependent variable: Performance1 (N = 150) Dependent variable: Performance2 (N = 136)

Independent variables Parameter estimates t-value p-value Independent variables Parameter estimates t-value p-value

Intercept −3.13⁎⁎ −3.56 b 0.01 Intercept −2.36⁎⁎ −2.82 b0.01

Prevent 0.33⁎⁎ 2.65 b 0.01 Prevent 0.25⁎ 2.16 0.03
MTB −0.31⁎⁎ −4.58 b 0.01 MTB −0.30⁎⁎ −4.67 b0.01
Size 0.22⁎⁎ 3.95 b 0.01 Size 0.18⁎⁎ 3.32 b0.01
Beta 0.01 0.02 0.99 Beta −0.11 −0.68 0.50
Prior1 0.33⁎⁎ 3.60 b 0.01 Prior2 0.26⁎⁎ 2.76 b0.01
Prevent*Prior1 0.01 0.01 0.99 Prevent*Prior2 0.14 1.28 0.20
F-statistic (p-value) 10.68 (p b 0.01) F-statistic (p-value) 10.51(p b 0.01)
Adjusted R2 0.28 Adjusted R2 0.30

Note: 1. Definitions of the variables appear in Table 1.

2. ⁎⁎ and ⁎ represent significance at the 1% and 5% levels with the two-tailed test, respectively.
3. The maximum VIF is 1.21, which is much less than 5, and thus multicollinearity is not a major concern.

Our research has some limitations that offer suggestions for future
work in this area. First, this study provides indirect evidence consistent
with the benefits of voluntary environmental overcompliance, in that
firms with better pollution records can improve their long-run financial
performance. However, future research may uncover more direct evi-
dence to validate the theory of overcompliance. Another limitation of
this study is that the sample firms are drawn from five highly polluting in-
dustries in Taiwan. Hence, the conclusions of the present study may not
fully generalize to other countries, even though Taiwanese accounting
standards in dealing with investments in pollution control facilities are
in compliance with both the U.S. GAAP and IFRS.
Acknowledgments
The authors thank two anonymous referees and F. J. Shiue, President
of the Taiwan Accounting Association for their invaluable advice. We
also wish to thank Arch Woodside and special issue co-editors for their
cordiality and encouragement through the review process. Research

Table 6
Additional Tests.

Panel A: regressions of Tobin's Q Panel B: regressions of long-run financial performance with Panel C: regression of long-run stock returns with
with control variables control the mis-classification of firms control variables

Dependent variable: Dependent variable: Dependent variable: Dependent variable: Dependent variable:
Tobin's q Performance1 Performance2 Return1 Return2

Independent Parameter Independent Parameter Independent Parameter Independent Parameter Independent Parameter
variable estimates variable estimates variable estimates variable estimates variable estimates

Intercept − 2.61⁎ Intercept − 4.98⁎⁎ Intercept − 3.79⁎⁎ Intercept 5.77⁎⁎ Intercept 2.41⁎
Prevent 0.40⁎ Prevent1 0.49⁎⁎ Prevent1 0.32⁎ Prevent 0.63⁎ Prevent 0.82
Size 0.15⁎ MTB − 0.29⁎⁎ MTB − 0.33⁎⁎ MTB 1.13⁎ MTB − 0.60
ROE − 3.50⁎⁎ Size 0.34⁎⁎ Size 0.28⁎⁎ Size − 2.33⁎⁎ Size − 0.03
SG 0.01 Beta − 0.01 Beta − 0.21 Beta − 1.05 Beta − 1.85⁎
Prior1 0.56⁎⁎ Prior1 0.34⁎⁎ Prior2 0.28⁎⁎
Prevent ∗ Prior1 0.03 Prevent1 ∗ Prior1 − 0.09 Prevent1 ∗ Prior2 − 0.01
F(p-value) = 6.20 (p b 0.01), F(p-value) = 9.16 (p b 0.01), F (p-value) = 7.34 (p b 0.01), F(p-value) = 20.39 F (p-value) = 2.56
Adj. R2 = 0.16, N = 159 Adj. R2 = 0.32, N = 105 Adj. R2 = 0.29, N = 94 (p b 0.01), Adj. R2 = 0.33, (p = 0.04), Adj. R2 = 0.05,
N = 156 N = 130

Note: 1. We follow Chung and Pruitt (1994) who define Tobin's Q as (Market Value of Equity + Preferred Stocks + Debt) / Total Assets. Let Year(t) be the year of investment.
Performance1 denotes the difference in the average factor score of Year(t + 1) to Year(t + 3) and Year(t − 3) to Year(t − 1), and Performance2 denotes the difference in the
average factor score of Year(t + 1) to Year(t + 5) and Year(t − 5) to Year(t− 1). Return1 denotes the cumulative three-year buy-and-hold returns. Return2 denotes the cumulative five-
year buy-and-hold returns. Prevent is an indicator variable that is set to a numerical value of 1 for firms with pollution prevention investments and 0 for firms with end-of-pipe pollution
control investments. Prevent1 is for firms with only pollution prevention or only end-of-pipe pollution control investments, and an indicator variable with the value of 1 for firms with
pollution prevention investments and 0 for firms with end-of-pipe pollution control investments. Size is defined as the natural logarithm of total assets. ROE is defined as the net income
to average equity. SG is defined as a sales growth percentage from the prior five year's sales. MTB is the ratio of a firm's market value of equity to its book value of equity. Beta is estimated
by running an OLS regression of individual stock returns on market returns. Prior1 represents the difference in factor scores between the investment year and Avg(−3,−1). Prior2 repre-
sents the difference in factor scores between the investment year and Avg(−5,−1). 2. ⁎⁎ and ⁎ represent significance at the 1% and 5% levels with the two-tailed test, respectively. 3. The
maximum VIF is 3.42, which is less than 5, and thus multicollinearity is not a major concern.
1642 C.-C. Chien, C.-W. Peng / Journal of Business Research 65 (2012) 1636–1642
support from the National Science Council, Taiwan (grant # NCS 83-
0301-H006-030) is gratefully acknowledged. All errors are our own.
Appendix A
A pollution control investment is categorized as end-of-pipe if it is
used to treat pollutants or waste water to comply with existing environ-
mental regulations, and as pollution prevention if it can also enhance
productive efficiency. The principles of categorizing investment in pollu-
tion prevention for these five highly polluting industries are summa-
rized as follows:
i. Cement industry: the major concern of the cement industry is dust
emissions in the production process. Investment in dust pollution
control equipment is categorized as prevention if it not only re-
duces atmospheric emissions, but also collects and recycles dust
particles into non-poisonous and useful raw materials.
ii. Plastics industry: waste plastic recovery equipment recycles
and converts waste plastics into valuable raw materials. The
exhaust heat recovery equipment used in this industry recycles
heat energy with flue gas. This increases the combustible air
temperature, avoids the loss of heat energy and reduces indus-
trial air pollution. These investments are categorized as pre-
vention investments.
iii. Chemical industry: the exhaust heat recovery equipment serves
a dual role as processing equipment and air pollution control
equipment, and is considered as a prevention investment.
iv. Paper and pulp industry: the waste recovery equipment and
equipments for prevention and control of pollutant emissions
are categorized as prevention investment.
v. Iron and steel industry: the steel industry uses cupola and induc-
tion furnaces to melt and decompose pig iron and scrap by utiliz-
ing fluidized bed combustion technology. The equipment for
reducing dust pollutants and also making improvements in the
production and manufacturing processes is categorized as a pre-
vention investment.
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