Is a Voluntary Approach an Effective Environmental Policy Instrument? A Case of Environmental Management Systems. Abstract

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1 Is a Voluntary Approach an Effectve Envronmental Polcy Instrument? A Case of Envronmental Management Systems Tosh H. Armura, Sopha Unversty 1 Akra Hbk, Natonal Insttute for Envronmental Studes & Tokyo Insttute of Technology Hajme Katayama, Unversty of Sydney 2 Abstract Governments exercse envronmental regulatons by mposng qualty/quantty lmts on emssons or requrng facltes to adopt specfc abatement technologes. Ths command-andcontrol approach has been crtczed, however, for cost-neffectveness and nflexblty. In response, polcy-makers started to adopt a voluntary approach along wth regulatons promotng facltes voluntary actons for envronmental protecton. The voluntary approach s crucally based on the two presumptons: (1) facltes voluntary actons have postve effects on envronmental protecton and (2) regulatons are not detrmental to the effects of voluntary actons. Ths paper, usng Japanese faclty-level data from an OECD survey, examnes the effectveness of two partcular voluntary actons: mplementaton of ISO 14001, the most wellknown certfed Envronmental Management System, and publcaton of envronmental reports. We separately quantfy the effect of those actons on three areas of mpact: natural resource usage, waste generaton, and wastewater effluent. The paper provdes three man fndngs. Frst, ISO helps reduce natural resource usage and waste generaton contnuously over years. Strkngly, wthout controllng for reports n keepng wth the exstng lterature, the effect of ISO14001 appears promnent for all areas of mpacts; however when reports are controlled for, the effect becomes smaller and t even becomes zero on wastewater effluent. Ths suggests the effect found n past studes s severely overestmated. Second, although ISO s a more common practce than provdng reports, the latter are more effectve than the former for two among the three mpacts. Fnally, we found that certan regulatons do not dscourage the effect of ISO Ths provdes a ratonale for governments proceedng wth both approaches concurrently. 1 Correspondng e-mal address s t-armu@sopha.ac.jp. 2 Emal: h.katayama@econ.usyd.edu.au 1

2 1. Introducton Tradtonally, governments n many countres exercse envronmental regulatons by mposng qualty/quantty lmts on emssons or requrng facltes 3 to adopt specfc abatement technologes. Ths command-and-control approach has been crtczed, however, for costneffectveness and nflexblty. For example, mandates to adopt specfc abatement methods make t mpossble for frms to use potentally less costly technologes, n addton to dscouragng the nnovaton of better alternatves (Coglanese and Nash, 2001). Economc ncentves such as polluton tax or emsson tradng have advantage over the command-andcontrol approach n terms of cost effectveness. However, the ntroducton of economc ncentves has been poltcally dffcult due to the opposton from manufacturng sectors or ndustry assocatons. As the governmental regulatons and the ntroducton of economc ncentves face lmtatons, polcy-makers have turned more attenton to a voluntary approach wth whch they attempt to promote frms voluntary actons. Ths approach s consdered as more promsng for beng more flexble, effectve, and less costly than the tradtonal regulatory approach. In addton, the voluntary approach can potentally reduce admnstratve burdens on envronmental agences. One of the frms voluntary actons s to mplement envronmental management systems (EMSs) 4. EMSs typcally consst of polcymakng, plannng, mplementng and revewng the envronmental polces, presumably helpng frms reduce envronmental mpacts. Government authortes n the US and Norway, for example, encourage frms to mplement EMSs by reducng the frequency of nspectons and/or provdng techncal assstance and nformaton that facltates EMS mplementaton. Ths polcy s crucally based on the assumpton that EMSs wll reduce frms energy consumpton, pollutng wastes, as well as ther rsk of future envronmental 3 In ths paper, we focus on facltes rather than frms as the subject of our analyss. A frm s a larger nsttute encompassng a faclty. Thus, a frm may consst of several facltes or one faclty can comprse a frm. Our focus on facltes was motvated by the followng reasons. Frst, the applcablty of envronmental regulaton dffers by locatons of facltes. A frm may consst of multple facltes, each of whch dfferent envronmental regulatons are mposed on. Thus, n order to analyze the effects of envronmental regulatons, faclty s a more approprate unt. Second, ISO14001, the most well-known certfed Envronmental Management System worldwde, s mplemented at a faclty level. In fact, the OECD survey, the data source of ths paper, targets facltes. 4 The Mnstry of the Envronment of Japan defnes an EMS as follows: An Envronmental Management System s a means that enables a company to undertake envronmental conservaton measures on a voluntary bass. The company sets up ts own envronmental prncples and goals, and establshes systems and procedures for ts factores and busness stes to mplement measures for achevng the goals. (Mnstry of Envronment, 2003) 2

3 lablty. However, mplementng an EMS may not necessarly mprove frms envronmental performance. Andrews et al. (2003) ponts out two possble cases where adoptng an EMS remans neffectve: (1) a frm that s achevng hgh envronmental performance may mplement an EMS whle remanng wth ts pre-exstng management and wthout commttng to any addtonal practce, and (2) a low-performng frm mplements an EMS to satsfy customers demands or to mprove ts publc mage wthout any actual change n performance. Although the effectveness of an EMS remans unclear, a growng number of frms n many countres are mplementng EMSs (see Fgures 1 and 2). Whle EMSs can ether be certfed or non-certfed, mplementng certfed EMSs, such as ISO standard (ISO 14001) and the EU Eco-Management and Audt Scheme (EMAS), s becomng more of a standard opton. In fact, t s already a standard n the automoble ndustry to adopt a certfed EMS. Snce 1996, major auto manufacturers have mplemented certfed EMSs and they requre supplers to do the same 5. Ths trend goes beyond the automoble ndustry. Major hgh-tech and computer companes, for example, ntroduced certfed EMSs and ther supplers are mplctly requred to mplement certfed EMSs. Hewlett-Packard expresses ther preference to exstng or potental supplers that have acheved ISO regstratons. Lkewse, Motorola expects supplers to have a certfed EMS lke ISO In response to the rapd growth of EMS certfed frms, researchers recently examne determnants of frms adopton of certfed EMSs and the effectveness of certfed EMSs on envronmental performance. Usng data on Japanese manufacturng frms, Nakamura et al. (2001) found that frm sze, the average age of frm employees, export rato, and debt rato are determnants of frms ISO adopton. Hbk et al. (2004) found that the ntroducton of ISO ncreases frms market value. Darnall (2003) emprcally shows that wth greater regulatory pressure, frms adopt ISO sooner. Examnng German manufacturng facltes decson on EMS certfcaton, Zegler and Rennngs (2004) observe that frms are lkely to mplement certfed EMSs when they perceve that certfcaton wll enhance ther corporate mage. Wth respect to the effectveness of certfed EMSs, fndngs from past studes are not necessarly n agreement. Russo (2002) and Potosk and Prakash (2005) provde evdence that ISO helps U.S. frms reduce ther envronmental mpacts. On the other hand, Zegler and Rennngs (2004) emprcally show that EMS certfcaton does not sgnfcantly affect envronmental nnovaton and abatement behavor of German manufacturng facltes. Dahlström 5 Supplers to Ford, General Motors and Toyota need to adopt ISO Damler-Benz and Volvo requre ther supplers to demonstrate certfable mplementaton of an EMS. 3

4 et al. (2003) argue that ISO or EMAS does not have a postve effect on complance wth envronmental legslatons. In addton to mplementng EMSs, frms can also take a voluntary acton by partcpatng n government-ntated voluntary programs. Yet agan, the effectveness of partcpaton n a voluntary program, accordng to the exstng lterature, s stll questonable. Welch et al. (2000) found that partcpants n the Energy s Clmate Wse program do not sgnfcantly mprove ther envronmental performance. In contrast, Khanna and Damon (1999) analyze the 33/50 Program undertaken by the Envronmental Protecton Agency (EPA) n the US 6. The authors found that partcpants of the program sgnfcantly reduce emssons more than non-partcpants. Another major voluntary envronmental practce s publshng envronmental reports. Reports are desgned to nform stakeholders (e.g. nvestors and consumers) of the frm s products and envronmental performance, whch gves the frm ncentves to decrease ts envronmental mpacts and to be nnovatve n the reducton of emssons. In fact, Hamlton (1995) found that frms gan ncentves to mprove ther envronmental performance by releasng ther envronmental report to the publc. Note that an EMS, for example ISO 14001, does not necessarly nvolve publcaton of envronmental reports. Publcaton of reports along wth EMSs may thus further enhance a frm s envronmental performance. The focus of ths paper wll be on two of the voluntary actons descrbed above: mplementaton of a certfed EMS, specfcally ISO 14001, and publcaton of envronmental reports. We examne the effect of these two voluntary actons on the facltes envronmental performance. We use Japanese faclty-level cross-sectonal data from a survey conducted by OECD. We separately quantfy the effect of those voluntary actons on three areas of envronmental mpact: (1) use of natural resources, (2) sold waste generaton, and (3) wastewater effluent. It s essental to dentfy whch area(s) of envronmental performance mproves ether by ISO 14001, envronmental reports, or both. By so dong, we can pn down whch voluntary actons are effectve on certan areas of performance. Ths may be useful nformaton for polcy makers, as they wll know whch acton they should encourage so as to reduce certan types of envronmental mpacts. Past studes typcally estmate the effect of ISO on envronmental performance wthout controllng frms other voluntary actons. Ths would lead to the omtted varable bas f other voluntary actons are ndeed effectve. Ths paper wll show the effect of ISO both when controllng for envronmental reports and when not. The estmaton results are strkng. Wthout controllng for reports n keepng wth the past lterature, the effect s sgnfcant; 6 The 33/50 Program encourages frms to voluntarly reduce ther emssons of toxc chemcals. 4

5 however, when reports are controlled for, the effect becomes smaller and dependng on the areas of envronmental mpacts, t even becomes zero. We also address a queston that has been left unanswered n prevous studes. That s, whether governments regulatons are not detrmental to the effect of frms voluntary actons on envronmental mpacts. Some governments take the command-and-control approach and a voluntary approach concurrently. Nevertheless, encouragng a frm s voluntary acton would be an neffectve polcy, f governments regulatons sgnfcantly dscourage the effect of the acton. We wll explore ths crtcal queston by examnng how the effect of ISO on envronmental performance changes n response to government regulatons. For frms envronmental performance, ths study uses self-reported ordered responses obtaned from a survey. To cope wth the nature of dependent varables and potental endogenetes of ISO and envronmental reports, we jontly estmate multple dscrete choce equatons wth endogenous dummes: three ordered probt equatons for envronmental performance, and two probt equatons for voluntary actons. Calculatng the lkelhood functon nvolves a hgh-dmensonal ntegraton, snce the latent errors n all the dscrete choce equatons need to be ntegrated out. To overcome ths, we adopt a Bayesan approach along wth the Markov Chan Monte Carlo (MCMC). In the next secton, we wll overvew ISO14001 and envronmental reports. We wll propose an econometrc model n Secton 3. Secton 4 dscusses determnants of mplementng ISO14001, publshng envronmental reports, and facltes envronmental performance. Secton 5 presents the estmaton results. In Secton 6, we conduct a smulaton to llustrate the effect of assstance programs by regulatory authortes on envronmental mpacts. Secton 7 concludes the paper. 2. An Overvew of ISO and Envronmental Reports ISO s a certfed EMS that specfes a system for facltes 7 to promote ther effort for reducng envronmental burdens generated by ther products, servces and actvtes. ISO s developed and mantaned by a non-governmental organzaton, the Internatonal Organzaton for Standardzaton (ISO), and thus there s no legal enforcement nvolved for a faclty to acqure ths certfcaton. To be ISO regstered or ready, a faclty has to demonstrate that ts EMS meets fve basc requrements: defnton of the faclty s envronmental 7 It should be mentoned that organzatons such as unverstes or muncpal offces obtan the certfcate as well. However, the share of those organzatons s small. Therefore, for the sake of avodng confusons over terms, we use facltes to refer to unts n general that are certfed wth ISO

6 polcy, project plannng (Plan) 8, mplementaton and operaton (Do), checkng (Check) and correctve acton (Act) and management revew 9. Thus, ISO14001 requres the faclty to follow the PDCA (Plan, Do, Check and Act.) cycle for the management to be effectve. Due to ths cycle, ISO s expected to reduce envronmental mpacts contnuously over tme; the adopters of ISO make a plan to reduce envronmental burdens for a few years and make contnuous efforts n mplementng t. If the EMS meets the requrements of ISO 14001, an accredted thrd-party wll certfy and regster the faclty. Regstraton n Japan costs between $15,000 and $17,000 for small and medum (from 2 to employees) to large szed (over 100 employees) facltes. If a faclty s n the category of envronmental damagng ndustry (e.g. chemcal, steel and ol), regstraton may cost between $23,000 and $26,000 dependng on ts sze. In order to mantan the certfcaton, a frm has to undergo a full re-certfcaton audt whch costs a half or two thrds of the ntal regstraton fee (Hbk et. al., 2004). Over the years, the number of facltes wth ISO s growng sgnfcantly. In the U.S., t grew from 291 to 3,553 n the fve years of 1998 through Japan experenced a more tremendous growth: beng 106 at the end of 1998, t reached 14,987 n 2004 (Fgure 3). As of June 2003, 46,836 facltes were beng certfed wth ISO worldwde, and nearly 25% of them (12,392) are located n Japan. The number by far surpasses that of the world s second most certfed naton, Unted Kngdom (3,960). Gven the crtcal proporton that Japanese facltes occupy n the entre fgure, ths paper uses Japanese data to emprcally nvestgate the effectveness of certfed EMSs, specfcally, ISO In addton to ISO14001, facltes may release reports to nform the envronmental mpacts that they are responsble for. Reports are consdered to facltate communcaton wth stakeholders (e.g. shareholders, fnancal nsttutons, nvestors, the consumers, envronmental NGOs, the governments, and local publc), whle nvtng the stakeholders montorng. In envronmental reports, they typcally provde polcy summares, targets and achevements n envronmental conservaton, the status quo of ther envronmental management, the current state of ther envronmental burdens and mtgaton measures. If ther targets are acheved and the achevement s reported, then facltes may set new targets and report the outcome n the future. Under such a crcumstance, the facltes may have ncentve for contnuously reducng ther mpacts. 8 An organzaton must defne the envronmental aspects of ts actvtes, products and servces, and ther sgnfcances of the mpact. 9 About once a year, faclty management needs to revew the EMS for ts completeness and effectveness. 6

7 Facltes that ssue envronmental reports have more ncentve to mprove ther envronmental performance than those who do not, snce the nformaton dsclosed n the reports may nfluence stakeholders decsons to purchase products or select nvestment targets. That s, as ther envronmental performance mproved, the corporaton mage also mproves and that n turn attracts stakeholders postve attenton. Followng ther parent companes or headquarters, an ncreasng number of related companes, subsdares, stes and plants are ssung envronmental reports 10. Ths type of reports s partcularly called ste envronmental reports. Accordng to A Survey on Envronmental-Frendly Companes ssued by the Mnstry of the Envronment of Japan, 40.9% of frms lsted n the stock market and 25.8% of non-lsted frms n Japan dsclosed envronmental nformaton n 1999 va Internet webstes, brochures, and reports. More than 15% of lsted frms publshed an envronmental report. Another source from the Mnstry of the Envronment of Japan (2001) shows that frms lsted socal responsblty, proportonal representaton, stakeholder relatons and envronmental educaton for employees as the man purpose for publcaton on an envronmental report n Japan. As ndcated n Fgure 4, a growng number of companes n Japan are ssung envronmental reports: n the past fve years the number has ncreased by 200 %. 3. Econometrc Model In ths secton, we present our econometrc model wth whch we analyze the effect of the two voluntary actons on three dfferent envronmental mpacts: (1) use of natural resources (j = 1), (2) sold waste generaton (j = 2), and (3) wastewater effluent (j = 3). Let polluton propensty for type j mpact. E j be faclty s E j s assumed to depend on a set of exogenous varables and the faclty s voluntary actons: the adopton of ISO and publshng envronmental reports. Defne two bnary varables ISO and ER as follows: ISO = 1 f the faclty adopts ISO and 0 otherwse. ER = 1 f the faclty publshes envronmental report and 0 otherwse. Faclty s polluton propensty for type j category s determned by E= θ +θ ISO +θ ER + γ w +ε, =1,,N, and j=1,2,3 (1) j 0j 1j 2j j 10 Based on Envronmental Reportng Gudelnes (Fscal Year 2000 Verson), ssued by the Mnstry of the Envronment of Japan (avalable at 7

8 where equaton. w s a vector of exogenous varables. Hereafter, we call equaton (1) the performance The faclty s polluton propensty E j s unobserved. What we observe s the faclty s ordered response E. j Ths varable represents the degree of a change n faclty s envronmental performance on type j mpact. There are 4 ordered responses: sgnfcant decrease ( E= 1), decrease ( E= j 2), No change ( E= j 3), and Increase ( E= j 4). We assume that j E = 1 f E µ j j j1 = 2 f µ < E µ j1 j j2 = 3 f µ < E µ = 4 f µ < E j2 j j3 j3 j (2) where µ jk, k=1,2,3 are threshold parameters. We defne µ j0 = - and µ j4 = + and µ j1 s µ = µ,µ,µ,µ,µ,µ ' for later use. normalzed to 0 for dentfcaton. Let ( ) If the two varables ISO and ER are exogenous and ε = ( ε,,ε ) 1 J ' are normally dstrbuted wth mean zero, the model would become a 3-varate ordered probt model wth certan normalzaton. Note, however, that ISO and ER are lkely to be correlated wth the latent error ε j, meanng that ISO and ER are potentally endogenous varables. It s because, for example, an nherently clean (or drty) faclty may tend to adopt ISO or vce versa. If ISO and ER are endogenous varables, estmatng a 3-varate ordered probt model wll generally lead to nconsstent estmates. For consstent estmates, we treat ISO and ER as dummy endogenous varables 11 (See Madala [1982]). Ths leads us to have two addtonal bnary choce equatons (hereafter called the adopton equatons ). Let ISO and ER be the net benefts from the adopton of ISO and from the publcaton of reports, respectvely. ISO and ER are determned by 11 In the survey, facltes are nqured whether they publsh envronmental reports or not. Hence, we understand that the facltes that answer yes publsh ste envronmental reports. In our study, we assume that the decson makng to publsh ste envronmental reports s made at the faclty level. 8

9 ISO = θ + δ z +ε (3) ER = θ + δ z +ε (4) where z s a set of exogenous varables. We assume that the faclty wll mplement ISO f ts net beft s greater than 0 and smlarly for envronmental reports. Ths means that ER are related to ISO and ER as follows: ISO and ISO = 1 f ISO 0 = 0 otherwse ER = 1 f ER 0 = 0 otherwse (5) (6) As a result, the estmaton model conssts of fve equatons: three envronmental performance equatons and two adopton equatons. For dentfcaton, more than two varables n z are excluded from. x We assume that ε = ( ε,ε,ε,ε,ε ) ' s normally dstrbuted wth zero mean and covarance matrx Σ. Wthout normalzaton, parameters n ths model are not dentfed. A straghtforward normalzaton s to set all dagonal terms of Σ to 1 s as n the multvarate probt model (for example, Chb and Greenberg, 1998). An alternatve normalzaton s to set the dagonal elements of the Cholesky decomposton of Σ to 1 s (González, 2003). We use the latter normalzaton, because t s computatonally convenent for our estmaton as we wll dscuss later. Calculatng the lkelhood functon nvolves a hgh dmensonal ntegraton snce the latent error ε needs to be ntegrated out. We adopt a Bayesan approach along wth the Markov Chan Monte Carlo (MCMC), by whch ntegraton over ε can be done straghtforwardly. The normalzaton proposed by González (2003) allows us to sample from the posteror dstrbuton of the parameters va the most wdely-used samplng method: the Gbbs samplng. We now dscuss the estmaton procedure. Let y y ( ) = E,E,E,ISO,ER, ( ) = E,E,E,ISO,ER, ( ) x = 1,ISO,ER, w ', k=1,2,3 k 9

10 ( ) = 1, z ', k=4,5 ( ) β = θ,θ,θ, δ ', k=1,2,3 k 0k 1k 2k k ( ) = θ, δ ', k=4,5 0k k Then, the system of the fve equatons can be expressed as y = Xβ + ε where X = dag ( x,, x ) and β = ( β β ) 1 5, K,. The model s determned by the parameters 1 5 β, Σ and µ. By the Bayes theorem, the jont posteror dstrbuton s gven by ( y βσµ y) ( y y βσµ ) ( βσµ ) π,,, π,,, π,,. Snce we choose ndependent pror dstrbutons for βσand, µ, the jont posteror becomes ( y βσµ y) ( y y βσµ ) ( β) ( Σ ) ( µ ) π,,, π,,, π π π where π ( β ), π ( Σ ) and π ( µ ) are the pror dstrbutons for β, Σ and µ, respectvely. We choose a dffuse pror for µ. The pror for β s a multvarate normal dstrbuton, a standard conjugate. The pror dstrbuton for Σ s an Inverted Wshart ~IW ( df, ) Σ K wth the restrcton that the dagonal elements of the Cholesky decomposton of Σ to 1 s. The posteror dstrbuton π (,,, ) from the full condtonal dstrbutons of β, Σ, ( Σ β y µ y ) π ( y βσµy,,, ) and ( ) π,,,, y βσµ y can be obtaned by successvely samplng y and : µ ( β Σ y µ y ) π,,,, π µ βσy,,, y, respectvely. All the full condtonal dstrbutons are well-known and therefore straghtforward to sample from. The exact forms of the full condtonal dstrbutons are descrbed n appendx. For estmaton, we set up the pror dstrbutons as follows: β ~N ( 0,10 I ) where m s the dmenson of β and Σ ~IW ( 7, I ) m wth the restrcton mentoned before. 40,000 MCMC teratons are mplemented. The frst 10,000 draws are used for burns-n and the next 30,000 are used to compute the posteror dstrbuton. 6 10

11 When reportng the posteror dstrbuton, we transform the smulated values of ( βσµ,, ) usng a more wdely-used normalzaton,.e., the dagonal elements of Σ beng all 1 s. Consequently, the transformed Σ s a correlaton matrx. 4. Background and Varables 4.1 Data We use Japanese data from the survey, Envronmental Polcy Tools and Frm-Level Management and Practces: An Internatonal Survey. The survey contans nformaton on envronmental practces and performances from manufacturng facltes n selected OECD countres ncludng Japan for the duraton of three years from 2001 to In the Japanese survey, 4,757 questonnares were sent n Aprl Reples were receved from 1,499 facltes, whch correspond to the response rate of approxmately 32 percent. Ths s relatvely a hgh response rate consderng the length of the questonnare. The survey conssts of sx sectons: 1) management systems and tools n your faclty, 2) envronmental measures, nnovaton and performance, 3) the nfluence of stakeholders and motvatons on envronmental practces, 4) publc envronmental polcy, 5) faclty characterstcs and 6) frm characterstcs. To examne the valdty of our sample, Hbk and Armura (2003) compare the dstrbuton of the faclty sze n our sample wth the Census of Manufactures n They conclude that the sample represents the entre country qute well n terms of the faclty sze. They also confrm the valdty of the samples n terms of ndustral classfcaton. More detaled nformaton on the results of the survey s descrbed n Hbk and Armura (2003). In the followng subsectons, we wll explan varables used n the estmaton. The lst of the varables s shown n Table 1-1. The summary statstcs of these varables s n Table 1-2. Although the sample sze s orgnally 1499, t s reduced to 792 for the estmaton due to mssng observatons. In the sample of 1499 facltes, 34% of them adopted ISO14001 whereas only 17% of them ssue envronmental reports. These voluntary actons n the sample for the estmaton are summarzed n Table Determnants of ISO14001 Adopton and Envronmental Report Publcaton Adoptng ISO and/or publshng envronmental reports depend on varous factors. The two envronmental actons stem from facltes voluntary ncentves to mprove ther publc mage and envronmental performance. The two actons are thus drven by smlar factors. For ths reason, we use the same varables both n the ISO adopton equaton and n the 11

12 envronmental reports equaton. In what follows, we descrbe nfluental factors for adoptng ISO Ths descrpton broadly apples to publshng envronmental reports as well. Faclty/Frm characterstcs Frst, the scale economy s expected to exst n adopton of ISO Snce ISO14001 requres the PDCA cycle descrbed n Secton 2, some of the employees must allocate certan hours to operate the cycle. If a faclty s small, t s dffcult to afford such labor force. Thus, larger-szed facltes are lkely to adopt ISO relatvely easer than smaller ones. The varable FACEMPL captures the sze of a faclty wth the number of employees n the faclty. In addton, faclty age may be an mportant factor. If a faclty s old, employees have developed ther work routnes and thus they may be reluctant to accept changes requred for the adopton. We therefore nclude a varable FACAGE to capture faclty age. The adopton s lkely to depend also on facltes busness performance. Both publcaton of envronmental reports and adopton of ISO14001 requre a certan amount of budget. Thus, facltes wll face dffcultes n adoptng ISO f they are under lqudty constrant. As a proxy for the facltes lqudty constrant, we nclude dummy varables to capture changes n facltes sales. A dummy varable SALEINC takes one f the faclty s sale ncreased n the three years. Smlarly, a dummy varable SALEDEC takes one f the sale decreased n the three years. The reference case here s no change n sales n the three years. Frm sze may also be an mportant factor n adoptng ISO Issung publc envronmental reports or obtanng the certfcates of ISO14001 ncurs some adjustment costs to a faclty snce they requre changes n the producton process, organzatonal structure or employees responsbltes. If other facltes n the same frm have adopted ISO 14001, managers of facltes can share ther knowledge and reduce the adjustment cost. Thus, we nclude a varable to capture frm sze wth the number of facltes. We also nclude a dummy, FRMINTL, whch takes one f the faclty s run by a foregn frm; f ther busness s run n nternatonal contexts, especally n Europe, US, or Canada, manufacturng frms are lkely to be envronmentally conscous due to hgher expectaton or stronger pressure on the frms for envronmental conservaton. Prme customers The type of prme customers may nfluence facltes adopton of ISO If ther prme customers are envronmentally-conscous wholesalers or households, facltes are lkely to adopt ISO n order to enhance ther publc mage as green facltes. In addton, other 12

13 manufacturng frms may request ther part supplers to adopt ISO If so, facltes have stronger ncentve to be certfed. By makng other manufacturng frms as a reference case of prme customers, we created the followng three dummy varables: PRIMECUST1, PRIMECUST2, and PRIMECUST3 whch take one f the prme customers of facltes products are 1) wholesalers, 2) households and 3) other facltes wthn the same frm, respectvely. Market scope Facltes market scope s another mportant factor of ISO adopton. If a faclty s market scope s global and ts product s exported to EU, US or Canada where ISO certfcaton s preferred or expected more than n Japan and ts neghborng countres such as Chna or South East Asan countres, the faclty s management has ncentve for adoptng ISO Ther ncentve s stronger than frms whose market scope s natonal and/or neghborng countres. We thus created dummy varables to capture the market scope. Dummy varables, MRKTSCOP1, MRKTSCOP2 and MRKTSCOP3, take one f the scope of the faclty s market s natonal, regonal (neghborng countres) and global, respectvely. The reference case of these dummy varables s the local market as a market scope. Envronmental regulatons and polcy Local governments at varous levels encourage facltes to apply an envronmental management system, for example, by deducng the frequency of ther regulatory nspectons f facltes adopt ISO Other authortes provde facltes wth fnancal support for the adopton. These polces are expected to have drect effects on the adopton. We constructed a dummy varable, PRGEMP, whch takes one f the faclty faces polces to encourage the adopton. Envronmental regulatons can promote the adopton n ndrect ways as well. Snce EMSs are expected to reduce envronmental mpacts, facltes facng envronmental regulatons have ncentves to adopt EMSs n order to ease the complance wth the regulatons. Thus, regulatons can promote the adopton of EMSs. Moreover, dfferent types of envronmental polcy nstruments may have dfferent effects on EMS adopton. For example, economc nstruments gve faclty managers strong ncentves to adopt EMSs n order to reduce cost whereas noneconomc nstruments may not. Informaton from the survey ncludes whch type of polcy nstruments are appled to the facltes. Among the polcy nstruments, we pay attenton to the followng polcy nstruments. The frst one s performance standards. A dummy varable, APL_PERSTD, takes one f a 12 See SONY s case as descrbed n the sub-secton, Stakeholders. 13

14 performance standard s applcable to the faclty. Performance standards have been a typcal form of envronmental regulaton n Japan. For example, to control ar polluton from facltes, an end-of-ppe emsson standard was ntroduced. Input tax s also an mportant nstrument that may affect facltes operaton. Governments have mposed nput tax on fossl fuel. The adopton of ISO14001 or envronmental reports may help faclty managers to have a better grasp of ther use of fossl fuel, whch can lead to cost savngs. A dummy varable, APL_INPTAX, s used to capture the applcablty of nput tax on facltes. Another potentally mportant polcy nstrument s polluton tax. The facltes n desgnated ndustral areas must pay charges for emttng SO 2 n Japan. Some muncpaltes mpose a levy on ndustral waste comng from outsde the areas for dsposal as a means of controllng waste volume. We use APL_POLTAX as a dummy varable to capture the applcablty of polluton tax. Lablty for envronmental damages can also be an mportant factor. In recent years, more decsons n lawsuts are gven aganst frms causng envronmental damages. For example, a major real estate company n Japan s crtczed to sell a condomnum unt wthout dsclosng ts contamnaton wth heavy metals. As the presdent of the company was prosecuted, the resdents of the condo receved refund not only from the estate company but also from the manufacturng faclty. As ths example llustrates, manufacturng facltes cannot neglect the rsk of lablty for envronmental damages. EMS adopton can help facltes reduce the rsk by better understandng ther envronmental mpacts. Thus, a dummy varable, APL_LIAB, s ncluded and the dummy takes one f lablty for envronmental damages has mpacts on the faclty s producton process. Fnally, a varable capturng water regulaton s constructed from another data source. Snce envronmental qualty standards for water were not attaned n many lakes or oceans, the Mnstry of the Envronment of Japan mplemented the ffth total-water-pollutant-land control. The regulaton assgns emsson allowance of a regulated substance and thus t s dfferent from a performance standard that lmts the weght of a regulated substance contaned n one ltter of water. Among the target of the regulaton were facltes n prefectures contanng the non-attanment lakes and sea areas. Ths new regulaton apples to new facltes n 2001 and to exstng facltes n To capture ths regulaton, we nclude a dummy varable WATER_REG that takes one f the faclty s located n the desgnated prefectures. Management practces A faclty engagng qualty control often acqures ISO 9000, an nternatonal certfcate for facltes qualty control. Lke ISO 14001, ISO 9000 also requres the PDCA cycle. 14

15 Introducng the cycle ncurs some adjustment cost, as the employees need to be traned and famlarzed wth the system n addton to ther exstng daly operaton. Yet f a faclty has the cycle n place beforehand by way of ISO 9000 certfcaton, t can expect lower adjustment cost to adopt ISO In ths way, the mplementaton of qualty management also asssts the adopton of ISO Therefore, we nclude a dummy varable OMPQMS to capture the mplementaton of qualty management control. Stakeholders We nclude dummy varables to capture the nfluence of varous stakeholders. Stakeholders may also nfluence facltes adopton of ISO Buyers of facltes products often encourage part supplers to be envronmental conscous. For example, SONY requests ts supplers to conform to the standards n SS-0259, a management regulaton defned by the company (CSR Report, 2004). Industral assocaton also encourages and/or asssts ther members to adopt EMSs Determnants of Envronmental Performance Explanatory Varables on Envronmental Performance Equatons The OECD survey nqures about changes n envronmental mpacts per output n the duraton of three years. The nformaton was collected n a form of ordered responses about the followng tems: 1) use of natural resources (energy, water, etc.), 2) sold waste generaton, 3) wastewater effluent, 4) local or regonal ar polluton, 5) greenhouse gases or ozone-depletng substances, 6) aesthetc effects (nose, smell, landscape), 7) sol contamnaton, 8) rsk of severe accdents, and 9) other negatve envronmental mpacts. Snce there are many mssng responses to 4) through 9), we focus on the frst three mpacts. We use the responses as dependent varables n the performance equatons. The summary statstcs on these varables are shown n Table 1-4. Varous factors may contrbute to changes n envronmental mpacts. Besdes faclty/frm characterstcs, one of the mportant factors s, as mentoned, the adopton of ISO and/or ssung envronmental reports. When consultants promote adopton of ISO n Japan, they clam that ISO s effectve n reducng the use of paper and electrcty and the amount of waste (ISOS, 2005). Energy consumpton savng and recyclng are possble through employee tranng and nsttutonal reform. On the other hand, n order to reduce wastewater effluent, facltes need to nstall equpments for polluton mtgaton and thus ISO may not be effectve n reducng wastewater effluent. Overall, ISO14001 s expected to have strong 13 See (n Japanese). 15

16 mpacts on the use of natural resources and sold waste generaton, but not on wastewater effluent. Envronmental reports, although t depends on facltes nformaton they dsclose, are expected to be effectve n general rather than certan areas of mpacts. In addton to examnng the effects of ISO and reports respectvely, we also address the relatonshp between the two. In publshng envronmental reports, facltes managers have to grasp every possble mpact of producton. The adopton of ISO wll help managers to collect nformaton on facltes envronmental mpacts. Thus, the effects of envronmental reports are lkely to depend on the adopton of ISO and vce versa. For ths reason we nclude a product of ISO dummy and envronmental report dummy. Another factor s envronmental polcy nstruments. A performance standard (APL_PERSTD) may change facltes envronmental mpacts per output. Introducton of a new performance standard s expected to reduce envronmental mpacts. On the other hand, exstng performance standards are expected to have no effect on the change, snce facltes have no ncentve to overcomply wth the standards. Input tax (APL_INPTAX) on fossl fuels s expected to gve facltes ncentves to reduce the use of natural resources for savng fuel costs. Lkewse, as some local authortes started to charge polluton tax on dumpng waste, polluton tax (APL_POLTAX) wll lkely reduce sold waste generaton from facltes. Lablty for envronmental damage (APL_LIAB) may nfluence waste generaton and wastewater effluent but not on the use of natural resources. A regulaton on water effluent (WATER_REG) potentally has mpacts on waste water effluent and the use of water. When facltes expect that ther sales or producton wll grow, they have to reduce waste water effluent per output to meet the assgned allowance under the regulaton. Also mportant to consder s the relatonshp between ISO and envronmental regulatons. Regulatons may substantally dscourage the effect of ISO For example, f an ISO-certfed faclty faces a regulaton whose requrement the faclty already satsfes, the faclty may not have an ncentve to set up a plan that wll overcomply wth the amount desgnated by the requrement. On the other hand, the same faclty mght have opted for a more ambguous plan f the requrement was not put n force. In short, the regulaton can be a turn-off for the faclty s ncentve for envronmental effort. In such a case, a regulaton s detrmental to the effect of ISO

17 Excluson Restrcton For dentfcaton, we exclude several explanatory varables n the adopton equatons from the performance equatons. Frst, a dummy for assstance programs of EMSs, PRGEMP, s excluded from the performance equatons. Assstance programs for EMSs are expected to promote EMSs, but not drectly affect the performance. Dummy varables of stakeholders are also excluded from the performance equatons. Stakeholders often request facltes to adopt EMSs or to comply wth envronmental regulatons. However, they do not necessarly drectly ask facltes to reduce envronmental mpacts. Also excluded from the performance equatons are varables regardng prme customers (PRIMECUST1, PRIMECUST2, and PRIMECUST3). For example, consumers as prme customers are lkely to be concerned wth envronmental mpacts of products but not producton processes. For ths reason we excluded varables that capture facltes producton process. Pressures form markets n developed countres gve facltes ncentves to make ther products to be envronmentally correct. Facltes are thus nclned to adopt EMSs as a sgnal for envronmental conscousness f ther market scope s global. However, those pressures do not necessarly affect the envronmental mpacts from producton process. Thus, varables on the global market scope (MRKTSCOP3) are excluded from the performance equatons. Smlarly, we excluded dummy varables on the natonal and regonal market scopes (.e. MRKTSCOP1 and MRKTSCOP2). The market structure s expected to nfluence the adopton of EMSs. For example, facltes may have an ncentve for the adopton n order to dfferentate themselves from compettors f the number of compettors s small. However, the stuaton on competton s less lkely to nfluence facltes mpacts drectly and thus the varable on market concentraton (MRKTCONC) s excluded from the performance equatons. So too s a dummy varable on frm s natonalty. If frms are from North Amerca or EU, they are lkely to be senstve to the concept of Corporaton Socal Responsblty (CSR). Thus, facltes n those frms are more lkely to adopt EMSs, as a sgnalng tool for envronmental conscousness or for the complance wth more strngent envronmental regulatons n ther home countres. However, those facltes do not necessarly have to reduce ther envronmental mpacts from ther producton process. Fnally, the dummy varable on qualty control s excluded as well. Although qualty control s expected to assst the adopton of EMSs, supposedly, t does not drectly affect envronmental mpacts. 17

18 5. Estmaton Results 5.1 Adopton Equatons (ISO and Envronmental Reports) Estmated coeffcents of the two adopton equatons are presented n Table 2. Table 3 contans the margnal effects that are calculated at the sample means of explanatory varables. In Table 4, we provde the correlaton matrx of the dsturbance terms. As CORR(4,5) n the frst column of Table 4 ndcates, the error term n the ISO14001 equaton s postvely correlated wth that n the report equaton. Ths result was expected, snce frms unobserved preferences over envronment are lkely to be captured by both dsturbance terms. Regardng the ISO equaton (hereafter, we call ISO as ISO, and ISO equaton as ISO equaton ), the coeffcent on FACEMPL s postve and sgnfcant at 5% level 14. Larger facltes are more lkely to adopt ISO, whch s consstent wth Nakamura et al. (2001), Hbk et al. (2004) and Welch et al. (2002). The postve and sgnfcant coeffcent on NFACS (the number of facltes) ndcates that f a frm conssts of a larger number of facltes, those facltes are lkely to adopt ISO. The coeffcent on FRMQUOT s postve and sgnfcant at 1% level. Facltes n lsted frms are more nclned to ISO adopton snce the adopton enhances the frms reputaton, postvely nfluencng ther stock prces. In fact, Hbk et al. (2004) confrms that a stock market values frms adopton of ISO. The postve and sgnfcant coeffcent on OMPQMS suggests that mplementaton of qualty management (ISO 9000) helps frms n the adopton of ISO, as s consstent wth Nakamura et al. (2001). Frms wth ISO 9000 have learned certfcaton processes, whch makes t relatvely easer to adopt ISO. Assstance programs by regulatory authortes ndeed promote frms adopton of ISO, as ndcated by the postve and sgnfcant coeffcent on PRGEMP. The probablty of a frm s mplementng ISO s ncreased by when an assstant program s offered. As we wll dscuss later, ISO reduces certan areas of frms envronmental mpacts. Ths suggests an ndrect effect of assstant programs on frms envronmental performance. That s, assstance programs promote frms to mplement ISO, whch n turn contrbutes to frms reducton n envronmental mpacts. Therefore, the results suggest the valdty of assstance programs as an envronmental polcy tool. A performance standard ncreases the probablty of frms ISO adopton by Facltes, when a performance-standard regulaton s mposed, may perceve ISO as a means to comply wth the regulaton and thus be tempted to adopt ISO. For example, managers typcally expect ISO to be useful n reducng the use of electrcty (ISOS, 2005). The estmaton result may suggest that managers dd adopt ISO n response to an energy conservaton law, a performance 14 By sgnfcant at the 5% level, we mean that zero s not n between 2.5 percentle and 97.5 percentle of the posteror dstrbuton. 18

19 standard revsed n the late 90 s, whch set a quantty target for reducng the use of electrcty or fossl fuel at facltes. In contrast, other polcy nstruments such as nput tax, polluton tax, lablty, and water regulatons do not sgnfcantly affect frms adopton. Input tax does not gve facltes ncentves to adopt ISO because ISO s not effectve n reducng nput tax. Polluton tax has no nfluence on ISO adopton because the amount of polluton tax s so low (Matsuno and Ueda, 1997) that facltes are not motvated to acqure ISO to reduce ther level polluton. As wll be dscussed n secton 5.2, lablty tself has no drect effect on envronmental mpacts. Thus, knowng the neffectveness, managers are not nfluenced by lablty n adoptng ISO. Smlarly, ISO does not have effects on wastewater effluent as we wll dscuss later. Snce the manger of facltes expects t, water regulaton does not promote the adopton of ISO. If t s perceved that corporate headquarters, employees and nvestors nfluence envronmental practces, facltes are lkely to adopt ISO. These results ndcate that the stakeholders wthn frms have two channels to affect facltes ISO adopton: top-down and bottom-up channels. In the former, the headquarter exercses strong nfluence on ISO adopton. In the latter, employees play an mportant role n adopton. Outsde frms, nvestors nfluence on adopton s lkely to be a consequence of the dffuson of CSR. If a faclty s prme customer s wholesalers, households, or other facltes wthn a frm, then t s less lkely to adopt ISO. The reference case s that the prme customer s other manufacturng frms. Thus, the estmaton results ndcate that facltes are most lkely to adopt ISO when ther prme customer s other manufacturng frms. Ths s expected n a sense that facltes are requested to adopt ISO by other manufacturng facltes but not by consumers or wholesalers. Moreover, ths s consstent wth the SONY s case n the prevous secton. In the envronmental report equaton (hereafter the report equaton ), the coeffcents on FACEMPL, NFACS, and FRMQUOT are postve and sgnfcant, lke those n the ISO equaton. The nterpretaton on the effect of these varables regardng ISO holds for envronmental report. Whle not sgnfcant n the ISO equaton, INFLIND ncreases facltes propensty to publsh reports. Ths suggests that some ndustral assocatons encourage facltes to publsh envronmental reports n an effectve way. On the contrary, PRIMCUST2 dscourages facltes to publsh envronmental reports, ndcatng that envronmental reports are not amed for wholesalers but for other manufacturng facltes or consumers. 19

20 5.2 Performance Equatons Tables 5, 6 and 7 present estmated coeffcents of the natural resource equaton, the waste generaton equaton, and the wasteful water equaton, respectvely. Table 8 shows the threshold parameters. Tables 9, 10, and 11 provde the margnal effects of explanatory varables. We estmate two dfferent models and these dffer n the treatment of a dummy endogenous varable. The frst specfcaton s our preferred one n whch we treat publshng reports as a dummy endogenous varable and nclude t nto the three performance equatons. In the second model, we exclude t from the three performance equatons. The latter resembles models that have been estmated n the lterature. Hereafter, we call the frst specfcaton Model 1 and the second Model 2. We frst dscuss the results of Model 1. As the frst column of Table 4 shows, CORR(4,2) s postve and sgnfcant. The error term n the ISO equaton s correlated wth the error terms n the waste generaton equaton. In addton, the error n the report equaton s correlated wth those n all three performance equatons. These results confrm the endogenty of the ISO adopton and publcatons of reports, justfyng our strategy of estmatng fve equatons jontly. In the natural resource equaton, the coeffcents on the two endogenous dummes (ISO and ER) are negatve and statstcally sgnfcant as shown n Table 5. Facltes whch mplement ISO and/or publsh reports sgnfcantly reduce natural resource usage over the three years. However, the two voluntary actons are not necessarly effectve for all areas of envronmental mpacts. Implementaton of ISO helps facltes reduce waste generatons (Table 6), whle not changng wasteful water (Table 7). The exact opposte s observed about envronmental reports: wasteful water s reduced whle waste generatons are not. These results suggest that 1) for facltes that greatly use natural resources the government should promote ether ISO, reports or both, 2) for facltes that generate substantal sold wastes, encouragng adopton of ISO would be a sensble polcy, and 3) for facltes that produce substantal amount of wasteful water, reports should rather be recommended. Note that these patterns, along wth the polcy suggestons, are not dentfed n past studes such as Russo (2002) and Potosk and Prakash (2005) because they examne the effect of ISO on a sngle performance measure,.e., an ndex of the emssons toxcty. It s mportant to note that each dependent varable s the degree of change n a certan mpact. Thus, the result ndcates that ISO contrbutes to reducng certan mpacts contnuously over years, whch s consstent wth the fact that, n accordance wth the PDCA cycle, the adopters of ISO make a plan to reduce envronmental burdens over a few years and attempt to mplement t. 20

21 When examnng the effectveness of ISO, past studes do not control for envronment practces such as envronmental reports that are not the component of ISO (e.g., Russo, 2002; Potosk and Prakash, 2005; Zegler and Rennngs, 2004; Armura et al. 2005). Some facltes, however, mplement ISO and publsh reports. Ths suggests that f reports are not controlled for and f reports are effectve, the effect of ISO would be overestmated, leadng researchers to wrongly conjecture that ISO help facltes mprove ther performance more than t actually does. To llustrate the sze of the omtted varable bas, we compared Model 1 to Model 2 n terms of coeffcents and margnal effects. In Model 1, the adopton of ISO ncreases the probablty of a faclty s reducng usage of natural resource by (= ), n comparson to by (= ) n Model 2. The bas would be 30 %! Smlarly, we observe a bas n the wasteful water equaton. When controllng for envronmental reports, we found that the coeffcent on ISO s not sgnfcant (Table 7). In contrast, the absence of envronmental reports n the equaton makes the coeffcent become negatve and sgnfcant at 1% level. Ths contrast s strkng, showng the crtcal consequence of not controllng for other envronmental practces. Accordngly, ISO s contrbuton to the faclty s performance found n the lterature becomes ndeed very questonable 15. Our results also suggest the varyng effects of dfferent envronmental practces. The adopton of ISO ncreases the probablty that a faclty reduces waste generatons by (= ), as presented n Table 11 (Model 1). Note, however, the margnal effect of reports s not sgnfcant. Ths means that a more comprehensve EMS (.e. ISO plus envronmental reports) would not necessarly mprove faclty s envronmental performance. In the wasteful water equaton, the margnal effect of ISO s much smaller than that of envronmental reports as shown n Table 10 (Model 1). In ths case, only one envronmental management practce (envronmental reports) s much more effectve to reduce wasteful water than ISO consstng of varous practces. To examne whether a more comprehensve EMS leads to better envronmental performance, Dasgupta et al. (2000) and Anton et al. (2004) use the number of adopted practces as a proxy for the comprehensveness of an EMS and regress t on frms emsson level or complance wth regulatons. Ther underlyng assumpton s that the effects of dfferent envronmental management practces are dentcal. However, ths assumpton appears to be too smplstc accordng to our results, snce one envronmental practce could be totally neffectve or could be much more effectve than another. 15 In the waste generaton equaton, the effect of ISO would not be based even f we do not nclude envronmental reports. Ths s because the publcaton of reports s not sgnfcant n the equaton. 21