Environmental Abatement Costs and Establishment Size

I. INTRODUCTION A vast body of literature has emerged examining the impact of environmental regulation on such outcomes as productivity, firm location, trade patterns, and foreign direct investment (for recent examples, see Levinson, 2001; List, 2001; Keller and Levinson, 1999; Jaffe and Palmer, 1997; Henderson, 1996; Jaffe et al., 1995). A more subtle effect of regulation receiving only a modest amount of empirical study is the impact of such regulation on industry structure and, in particular, firm or plant size. Conrad and Wang (1993) and the subsequent comment by Kohn (1997) analyze this issue theoretically. Becker and Henderson (1999, 2000), Dean et al. (2000), and Ollinger and Fernandez-Cornejo (1998), analyzing data from the United States, and Golombek and Raknerud (1997), using Norwegian data, are the most recent additions to the empirical literature. The aim of the present study is to contribute to the empirical debate over the effect of environmental regulation on the size of manufacturing establishments (physical buildings). Environmental regulations have long been suspected of having differential effects on establishments of varying sizes. (1) Compliance asymmetries are the most common explanation of the regulatory--size interaction. Brock and Evans (1985, 1986) argue that because pollution control is capital-intensive and typically involves high fixed costs, optimal plant size increases with regulatory intensity. Kohn (1997) shows that the effect of emission taxes depends crucially on the assumption about the returns to scale in abatement technology; increasing returns may lead to an increase in the scale of polluting firms. Empirically, Becker and Henderson (1999, 2000) find that new firms in ozone-intensive industries (industrial organic chemicals, miscellaneous plastic products, and wood furniture) begin initially larger in counties in nonattainment of the U.S. Clean Air Act's ozone requirements but invest less in the future. Dean et al. (2000) find entries of small manufacturing establishments to be lower in sectors with hi gher average expenditure on pollution abatement per unit of value added. Ollinger and Fernandez-Cornejo (1998) document that greater regulatory costs in the U.S. pesticide industry had a more detrimental effect on smaller firms. Pashigian (1984) finds that pollution control reduces the number of manufacturing plants and increases the minimum efficient scale (MES) of production, thereby lowering the market share of smaller plants. Pittman (1981) supports a similar increase in MES in pulp and paper mills. Related asymmetries may arise due to administrative, legal, or statutory differences across establishments of different sizes. Smaller plants may lack the resources necessary to investigate regulatory changes, and larger establishments are able to spread such administrative fixed costs over a larger output, thus lowering cost per unit of production (Dean and Brown, 1995). In addition, Yeager (1987, p. 333) finds that larger firms are able to devote more resources to legal challenges of Environmental Protection Agency (EPA)-imposed sanctions, typically resulting in "more favorable terms of imposed regulations." On the other hand, Ringleb and Wiggins (1990) find that firms that expose their employees to higher levels of toxins during production-related activities tend to be smaller and have lower survival rates to avoid future lawsuits. Similarly, establishments may downsize and have lower survival rates to avoid class-action lawsuits over environmental damages to surrounding communities. Moreover, Greve (1989) argues that environmental groups filed notices of intent to sue larger firms under the U.S. Clean Water Act--even though the firms being sued were not necessarily the worst polluters--because larger firms are more likely to settle to avoid negative publicity. Finally, statutory asymmetries may exist if regulations specifically target or exempt plants of a certain size. …