Greener nations, smarter firms? : a study of environmental policy stringency and investment efficiency

Abstract

This paper examines the relationship between environmental policy stringency and investment efficiency, using data from 1,221 firms across 21 OECD countries over the period 2005 to 2023. Using fixed effects panel data techniques and instrumental variable (IV) approach to address for potential endogeneity, we find robust empirical evidence that environmental policy stringency increases investment efficiency of firms by reducing underinvestment scenarios. We provide empirical evidence that environmental policy stringency affects investment efficiency by reducing financial constraints, lowering information asymmetry, and firm risk. Further analysis explores the extreme cases of the stringency of environmental policies, suggesting that moderate stringency encourages investment efficiency. Overall, our results highlight the importance of environmental policies on investment efficiency.