Association for Public Policy Analysis & Management

The Porter hypothesis suggested that when environmental regulation is strong, firms would choose to invest in pollution control technology, in order to maximize their long term profit and prosperity. This paper examines the tradeoff between investing in pollution control and paying pollution levy made by the hard to reach small and medium sized enterprises (SMEs) in China, using the National Private Firm Biannual Survey data 2008-2014. We assume those 3,753 private firms aim to maximize profit and minimize pollution levy paid to the government. Adopting a simultaneous equation approach, we disentangled the inter-connections between a firm’s economic performance, environmental behaviors, and corporate governance, controlling for firms’ location and socio-demographic features of firm managers. More specifically, we identified the determinants of and inter-relationship between the following set of three dependent variables, “profit”, “pollution levy”, and “investment in pollution control.” We found a firm’s profitability is negatively associated with labor cost and positively associated with capital cost, but not associated with any other factors, such as pollution levy, ownership, corporate decision-making structure, or owner’s membership with the Communist Party of China or the Federation of Industry and Commerce. Furthermore, we found a firm’s pollution levy paid is negatively associated with its profitability and positively associated with its investment in pollution treatment, being a limited liability company, and its owner being a member of the Federation of Industry and Commerce.