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“Carrot And Stick: How Can Firms Better Influence Each Other’s Environmental Behavior?”
New research by Zahra Hashemzadeh and coauthors from the department of Economics at Lund University analyzed the environmental policies carried out by companies. The results shed lights on the role played by firms’ networks in environmental policies adoption with relevant implications for policy making.
Text by Zahra Hashemzadeh
Environmental impacts are one of the most common examples of an externality effect in economics. A firm’s activity, such industrial production, may cause a negative impact on the environment experienced by an unrelated third party, such as polluted air or water. On a global scale, no single country or group of countries can enforce environmental standards on companies in other countries, but each is very much affected by, for example, the greenhouse-gas emissions those foreign companies generate. Multinational cooperation through bodies such as United Nations can pave the way forward, but this tends to be slow and subject to political shifts. Another channel to tackle this concern could be by firms motivating each other to improve their environmental performance either by the carrot or the stick. To shed light on this topic, Asgharian et al. (2021) have studied companies’ networks as a global conduit for environmental policies and actions in a recent working paper.
Networks of companies affect the impact of environmental policies.
Relationships in a firm’s network can take different forms, such as between competitors, customers, and suppliers, or partnerships focused on, for example, joint research or operational activities. Looking at a large international sample of 2,842 firms over the period 2004 to 2019 in 51 countries, the results show that big companies strongly affect their related stakeholder firms, such as suppliers, but are not themselves affected much in return. Specifically, firms with a larger market share and more connections in the network induce a stronger impact on other related firms but are themselves less impacted with respect to their own environment performance by these firms. As a result, they – the large companies - are expected to be the driving force of environmental policies and are less sensitive to the policies implemented by firms in weaker positions. Moreover, this analysis finds that this is more noticeable when two related firms are competitors. Interestingly, this phenomenon transpires most when the environmental performance of the related firm changes positively and the focal firm belongs to the category of poor performing firms (below-median environmental performance.)
The transmission of environmental policies influence is industry-specific.
The paper also compares the transmission effect considering different industry characteristics. The transmission effect is more evident when the industry is concentrated - where a few large companies have a very high market share in the industry. One explanation for this could be that companies in a highly concentrated industry segments are more subject to scrutiny, which may force them to enhance their environmental impacts if rivals do so, otherwise they may lose their market share. Furthermore, the research finds that the spill-over is greater in industries where environmental issues are also economically relevant for firms’ activity. Another industry characteristic is proximity to the final consumer. Firms operating in consumer-facing industries more strongly influence each other. This confirms that widespread public pressure improves firms’ attitude toward environmental issues.
To alleviate concerns around subjectivity in research outcomes which may occur from the use of environmental perfoance ratings, the study also focused on more objective and tangible metrics such as changes in the companies’ CO2 emissions. The good news is the results remain unchanged.
Environmental policy effort can be morrme effective in well-connected and concentrated sectors.
All in all, the main takeaway of this paper is that to maximize the “ripple effects” of positive environmental impacts across a company’s network, the focus should be on strongly-connected and with a large market share in highly concentrated industries for whom the environment is a financially material issue. These findings may help guide regulators, activists, and other interested stakeholders (for example, customers and suppliers) towards the most promising targets for generating better green outcomes. This could be significant given the limited time and resources available to bring about much needed environmental performance improvements. The results should also encourage managers of such firms to take the lead in improving their environmental track record, knowing that their actions will hrough their companies’ networks and generate positive externalities. The upshot is that network transmission acts to improve firms’ environmental performance, alsspread to in terms of real outcomes, such as reducing CO2 emissions.
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This research was carried on as part of the author’s PhD studies at the Department of Economics at Lund University. In addition to the topics from this article, Hashemzadeh (2022) analysed whether and when a sustainability review on an investment decision leads to return premiums while seeking environment-friendliness. Following this, the two other essays included in this dissertation study how financial markets in different countries react to environmental awareness. The papers shed light on motivations for environmental considerations and provide a more holistic picture of sustainability integration in the economy and financial markets.
Asgharian, Hossein and Dzieliński, Michał, Hashemzadeh, Zahra and Liu, Lu, “Green Links: Corporate Networks and Environmental Performance” (2021).
Hashemzadeh, Zahra (2022) “Drivers of Going Green in Financial Markets and Corporate Networks“, Lund Economic Studies, 232