The Influences of Multi-Level Environmental Regulations on Firm Performance in China

2.1 Environment Regulations and Firm Performance

The existing literature presents divergent views on how environmental regulations affect business performance. Factors influencing firm performance span various domains, including economic conditions, government policies, social impacts, technological advancements, and market dynamics. Research across multiple studies, such as those referenced, has highlighted the intricate interplay of these factors on firms. Economic stability or downturns directly affect consumer spending, impacting firms’ revenue streams, including the economic activities in the supply chain. Government policies wield substantial influence, from taxation structures to trade agreements, altering operational costs and market access. Social factors, including changing demographics or cultural shifts, mold consumer preferences and market demands, crucial to firms’ strategic planning (Ghaedamini Harouni et al., 2023; Ghanbari et al., 2022; Taşkan & Karatop, 2022).

However, amidst this multifaceted landscape, environmental regulations emerge as the foremost influential factor for firms. Environmental policies, often stringent and evolving, wield profound impacts across industries. Stringent regulations compel firms to innovate and adopt sustainable practices, impacting production processes, resource allocation, and compliance costs. Firms navigating these regulations face heightened pressures to reduce carbon footprints, adopt eco-friendly technologies, and ensure responsible resource usage. Such endeavors significantly affect operational expenses and supply chain dynamics, altering the competitive landscape.

Moreover, the significance of environmental regulations stems from their pervasive nature, transcending borders and industries. Global efforts toward environmental sustainability, exemplified by initiatives like the Paris Agreement, amplify the regulatory impact on firms worldwide. Compliance with these regulations is not merely a legal necessity; it is increasingly intertwined with brand image, consumer perceptions, and market competitiveness. Firms embracing sustainability tend to garner favor among environmentally conscious consumers and investors, thereby influencing market positioning and long-term viability.

Furthermore, environmental regulations catalyze innovation and drive technological advancements. Firms invest in research and development to create eco-friendly products and processes, fostering a culture of innovation that can yield competitive advantages beyond regulatory compliance. Collaboration and partnerships become instrumental in navigating these regulations, fostering industry-wide efforts toward sustainability.

In essence, while economic, governmental, social, and technological factors exert significant influence on firms, environmental regulations stand out as the most impactful. The gravity of these regulations transcends mere compliance; they redefine operational paradigms, shape market behaviours, and dictate firms’ long-term sustainability strategies. Embracing environmentally conscious practices is not just a legal obligation; it is a strategic imperative for firms seeking resilience, innovation, and enduring relevance in a rapidly evolving global landscape.

Traditional neo-classical environmental economics suggests that regulations tend to impose additional costs, such as emission taxes and investments in green technologies, which can negatively impact corporate profitability (Sari & Tjen, 2017; Yuan & Xiang, 2018). These costs can act as deterrents to investments in production and other activities, ultimately undermining business performance. On the contrary, proponents of the PH argue that regulations serve as drivers of positive change. By obliging corporations to innovate technologically and adapt their production methods, regulations can lead to increased efficiency and the development of new products, potentially offsetting compliance costs (Mohr, 2002; Mohr & Saha, 2008).

Different types of regulations play a crucial role in shaping the outcomes. The “weak” version of the PH suggests that stringent policies encourage specific types of innovation (Jaffe & Palmer, 1997). Stringency often manifests as specific indicators like direct emission standards imposed on corporations. The “narrow” version posits that flexible regulations, such as tradable emission permits, offer greater incentives for innovation by providing “room” for identifying feasible abatement opportunities (Arimura et al., 2007). Finally, the “strong” version contends that well-designed regulations, combining stringency and flexibility, can stimulate innovation that generates returns surpassing compliance costs, thereby enhancing corporate economic performance (Lanoie et al., 2011).

However, empirical research attempting to validate these hypotheses has yielded diverse findings. For instance, Testa, Iraldo, and Frey’s analysis of the building and construction sector in certain European Union (EU) regions suggests that well-structured direct regulations effectively promote innovation and economic performance, while economic instruments have a negative impact on business indicators (Testa et al., 2011). Lanoie et al.’s study across manufacturing industries in seven OECD countries provides support for the “weak” version, limited support for the “narrow” version, and does not endorse the “strong” version (Lanoie et al., 2011). Zhao et al.’s research on China’s major environmental regulations and their effects on energy firms’ stock prices reveals mixed outcomes, depending on the category of the regulation (Zhao et al., 2018).

2.2 The Influences of Environmental Regulations from a Multi-Level Perspective

Besides the types of regulations, the heterogeneity on firms, industries and institutions also alter the influences of regulations on corporates’ innovation and performance. Some studies emphasize the importance of both organizational and sectoral characteristics (DeCanio, 1998; DeCanio et al., 2000). Organizational structure, management practice, and personal values of the managers significantly affect the decision-making of a corporate under environmental regulations (Arimura et al., 2007). The same regulatory practice may exert distinct influences on different sectors due to the varied uses of raw materials and processes of production (Yuan et al., 2017). Wang and Shen find that environmental regulations in China positively affect clean production industries, but such effects are lagged on pollution-intensive industries (Wang & Shen, 2016). Rexhäuser and Rammer analyze how environmental regulations in Germany influence profitability of different corporates and conclude that only firms generating both regulation-driven and voluntary innovations on improving producing efficiency can promote their profitability (Rexhäuser & Rammer, 2014).

Compared with organizational and sectoral features, the institutional contexts in which the regulations and corporates are embedded receive less attention. Most of the existing studies categorize environmental regulations according to policy stringency. However, regulations can also be divided by the policy makers with different intentions. The central government needs to consider the regional disparity and comes up with universal guidance applied across the country. The local government considers more about the local specificities and designs local context-based policies to enrich and supplement the central guidance. The United Kingdom has been prioritizing carbon reduction in the last several years and formally committed to realize zero net carbon emission by 2050 in 2019. In this situation, the Mayor’s London Environment Strategy was published with six aspects that London needs to improve before 2050. For every aspect, there were detailed regulation measures and implementation plans. Gibbs and Jonas emphasize that, though environmental policy-making is rescaling from international and national levels to the local level of the state, the making of regulations and their influences should be considered across all government levels (Gibbs & Jonas, 2000).

In some cases, the organizational structure of corporate cannot be discussed separately from the institutional context when there is close connection between the government and corporates. SOEs are common in national strategic industries so that the government can better control the economy. In the OECD countries, SOEs take leading positions in the electricity and gas industries, while the transportation sector is closely monitored by environmental policy makers (Christiansen, 2011). In China, SOEs play an important role in almost all sectors, especially in the heavy industries (Fu et al., 2021; Zhou et al., 2017). Compared with private companies, SOEs need to bear more environmental responsibilities and help the government with environmental objectives. Thus, the managers may make decisions that contribute to environmental protection instead of economic benefits (Shah et al., 2021). On the other hand, SOEs receive more preferential treatment from the government that make them adapt to the regulations more efficiently and achieve better performance (Shi & Xu, 2018).

The relations between environmental regulations and firm performance are complicated by types of regulations, sectoral, and organizational features and the multi-level interaction between government at different levels and corporates. Then a case study used by this article that focuses on a specific corporate with first-hand interviews provides opportunities to reveal accurate relations compared with constructing econometric models that may suffer from omitting variables, selection bias, multi-collinearity, and other technical issues. In China, more environmental regulations are stringent rather than flexible. The common situation is that the government publishes specific emission standards and punitive measures including fines, circulated notices of criticism, mandatory rectification, and business shutdown for the corporates that cannot meet the standards (He et al., 2020). In the study by Zhao et al. (2018), it was found that the 20 major environmental regulations consist of 16 legislative and administrative standards, only 2 market-based regulations and 2 environmental information disclosures. This article therefore focuses on the stringent government regulations represented by the prescriptive standards. The environmental regulations in China mainly target at pollution-intensive industries to promote the industrial restructuring and upgrade. This article selects SYPC, the leading SOE in the petroleum industry that actively implements environmental policies. The SINOPEC headquarters pays attention to both stringent policies and flexible instruments as it designs emission standards and performance management systems for subsidiaries. This study focuses on SYPC, a prominent player in the petrochemical industry in China. It examines how SYPC has managed to adapt to stringent environmental regulations while maintaining its economic performance. We recognize that regulations at multiple levels, from central to local governments, can pose challenges for businesses. SYPC’s experience serves as a case study to highlight practical strategies employed by companies to balance environmental responsibilities and economic interests.

2.3 The Context of China

China, as a global industrial powerhouse, faces unique challenges in environmental regulation. The government’s role in SOEs adds complexity to the business landscape. SOEs like SYPC play a crucial role in driving environmental objectives while navigating economic realities. Understanding the political structure and development of SOEs in China is important to analyse the multi-level interaction between government levels and corporates. China’s environmental regulations operate within a multi-level governance framework, where responsibilities are distributed among national, provincial, and local authorities. At the national level, central government bodies like the Ministry of Ecology and Environment (MEE) set overarching policies and standards. Provinces then adapt these guidelines to suit regional conditions, often with their own specific regulations. Local governments enforce these regulations and may have additional measures to address local environmental challenges. Meanwhile, to improve efficiency, local governments are entitled with decision-making on but also need to self-finance local economic, social, environmental and cultural affairs (Xu, 2011). To create more fiscal income and higher GDP, local governments may sometimes circumvent or ignore central policies such as acquiescence in the operation of corporates that create considerable economic benefits but emit excessive pollutants.^[1] This tiered system allows for flexibility in implementation while ensuring alignment with national environmental objectives.

Central and local SOEs dominate the manufacturing sector in China (Wei et al., 2002). The central/local government holds full, majority of, or significant minority of the shares of SOEs mainly through the central-/local state-owned assets supervision and administration commission (SASAC). The board chairman, chief executives, and managers of SOEs are recommended or directly nominated by SASAC (Lin, 2017). Some large central SOEs usually set their headquarters in Beijing and distribute subsidiaries across the country. Some branch companies have an integrate production system and the decision-making of firm strategies, but they also answer to the headquarters by serving the development goals of group company and following the rules and regulations made by headquarters (Szamosszegi & Kyle, 2011). Although without local SASAC being the shareholder, branches of central SOEs also aim to build good relations with local authority in most cases for a better operating environment as local governments control natural resources in the locality and have profound influences on local markets.

There are extensive studies that examine the influences of environmental regulations on firm performance in China, with SOEs as a popular focus. SOEs are given stricter emission standards by the government because of their exemplar effects (Wang & Wheeler, 2005). They are also pioneers of implementing environmental regulations by using green technology (Cai et al., 2020; Wang & Shen, 2016) compared to firms of other ownerships. Such behaviours may undermine firm performance in particular situations but do not stop the enthusiasm of the managers since realizing government objectives benefit both their personal income and corporate development in the long term (Guo et al., 2017; Jian et al., 2020). Meanwhile, the preferential treatment, particularly the “soft budget control” which means that SOEs are backed by capital and credit of the government, makes these companies better adapt to regulations (Maurel & Pernet, 2021). However, there are also cases that SOEs ignore local environmental regulations. This happens when a branch of large central SOEs has higher administrative levels than the city or county and significantly contributes to local economy (Eaton & Kostka, 2017).

4.1 The Central Level: Guiding Concepts and Detailed Standards

The central government holds primary responsibility for making and enforcing environmental regulations, providing guiding concepts and detailed instructions outlined in the Five-Year Plans (FYPs). The FYPs published by the State Council set the course of national development for every 5 years. Since the 6th FYP in the late 1970s, every plan has mentioned and increasingly highlighted the importance of environmental protection (Kostka & Mol, 2013). In 2011, for the first time in the national congress, the 12th FYP formally proposed green development as a national priority and promoted a strategic transformation toward an eco-friendlier mode of the environmental management. The plan raised a target to reduce CO₂ emission per unit GDP by 17% by the end of 2015 compared with that of 2010. To achieve the target, central departments represented by the MEE published dozens of policy documents with nearly 2000 specific standards on environmental activities for local governments and corporates, including pollutant discharge levels measured by individual factory, county, city, and province; monitoring range and frequencies of local governments on corporates; punishing measures for corporates violating regulations, etc.

For the regulations from the central government, one manager of SYPC confirmed their effects on promoting technological innovation.

In 2008, we innovated our technology to carry out the concept of ‘scientific outlook on development (ke xue fa zhan guan)’ and overfulfilled the annual target of the firm on saving water, gas and electricity. In 2012, the company strived to be the leader of ‘ecological civilization (sheng tai wen ming)’ and the builder of ‘Beautiful China (mei li zhong guo)’. A three-level resources recycling system was built to reuse tail gas and waste water. In 2018, we actively implemented the idea ‘lucid waters and lush mountains are invaluable assets (lv shui qing shan jiu shi jin shan yin shan)’ and furthered the existing plans on emission reduction, waste treatment and upgrade on green production procedures.

The concepts mentioned by the manager were raised by the former president Hu Jintao and the current president Xi Jinping and were written in the FYPs in the 2000s and 2010s as guiding ideologies to emphasize environmental protection during promoting economic development. Notably, adherence to central instructions impacts promotions for local officials and central SOE managers, signifying their importance within the regulatory landscape. For the reason, he said:

We met all the standards in 10th, 11th and 12th FYPs. We surely abide by the standards of MEE, but we pay more attention to the regulations from Jiangsu and Nanjing governments and those made by the headquarters. They are at least of the same standard as the central ones. In more cases they are stricter.

Compared with the detailed criteria, guiding concepts of the central government better incentivize SYPC to innovate technology. Such concepts are neither stringent nor flexible instruments and are of Chinese characteristics. They set the direction and leave space for policy executors to come up with specific methods. Though being broad, sometimes obscure, and resulting in unsuccessful implementation, they are valued by the local governments and corporates, particularly SOEs (Kostka & Nahm, 2017). Following the central instructions are key to whether local officials can be promoted to a higher-level position, and whether central SOE managers can be promoted or earn extra income.^[2]

4.2 The Local Level: Tailored Policies and Supervision

Local governments modify central regulatory measures or devise new measures to suit local contexts (Heberer & Senz, 2011). Jiangsu and Nanjing governments mainly use two methods to produce local environmental regulations: modifying central regulatory measures and coming up with new measures under central guidelines.

An example for the first method is the modification of the emission standards for the petrochemical industry published by MEE in 2015.^[3] MEE designed two sets of maximum concentration levels for water pollutant emission (Table 1). Places with smaller environmental capacity, fragile ecological system and higher level of territory development should follow the stricter set of standards called the ‘special standards’. The decision about which places fell into this category was made by provincial governments after consulting MEE. Based on the MEE standards, Department of Ecology and Environment of Jiangsu (DEEJ) published emission standards for firms in the province (DEEJ, 2020). In the introduction page, the policy document stated that “The document aims to implement the central policies on environmental protection. The standards are made by modifying those in the MEE document with local situations.” MEE stipulated that the concentration levels of chemical oxygen demand (COD) could not exceed 60 mg/L in most cases. The “special standard” was 50 mg/L. The standard for corporates producing epichlorohydrin, naphthalene series compounds, epoxypropane, and six other chemical products was 100 mg/L. With these thresholds, Jiangsu first matched the name of chemicals to specific industries according to the existing industrial structure in the province. Then more thresholds within the range set by MEE were added for these industries to form more detailed and clearer instructions. These thresholds were made based on historic emission levels of the industries to make sure that the firms could adapt to the rules (Table 1). Apart from COD, similar revise was applied to other chemicals listed in the MEE documents.

An example for the second method is the “263” special project initiated by Jiangsu Government in 2017.^[4] The targets of the project were reducing the consuming amount of coal and the production capacity of traditional petrochemical engineering (the “2”); managing water quality of Taihu Lake, household waste, watercourses, VOCs, pollution of the animal husbandry, and other environmental hazards (the “6”); and improving ecological protection, law enforcement, and supervision and economic regulations (the “3”). There were 11 subprojects for every aspect with specific quantitative targets. For instance, the whole province should reduce the amount of coal consumption by 32 million tons by 2020, replace the coal-firing boilers with the power less than 10-ton vapour per hour with clean energy alternatives by the end of 2017, and finish renovation of the 52 provincial industrial parks. The special project supplemented the central policies with practical actions as it seldom set new standards but explicitly pointed out what should be done to meet the given standards. The regulations from central government cannot provide such details in the policy execution due to the unfamiliarity with local situations. By modifying central standards and making practical implementation plans, the local governments can efficiently carry out environmental regulations.

Though the central government dispatches environmental inspection teams across the country, the frequency for every place is low because of the vast territory and the limited number of staff. Therefore, the other important part of local environmental regulations is supervision and punishment on corporates. Provincial and municipal governments have different focuses on how to supervise and punish. First, the provincial government issues specific supervising and punishing measures and organizes teams of experts and officials to inspect into firms regularly and occasionally. For supervision, the Jiangsu Government enacted a method on supervising pollutant discharge in 2019 (DEEJ, 2019). The method proposed three ways of firms monitoring emission by themselves, including commissioning agencies for manual monitor, manual self-monitor, and automatic self-monitor. Emission levels of SO₂, particulate matter, and 11 other pollutants were used for evaluation. The results should be disclosed comprehensively and in time. For punishment, in 2008, the Jiangsu Government published the hardest punishing measures across the country on excessive emission with the maximum of 1 million Yuan fine, and the notice of criticism or warning circulated on government and social platforms and even the mandatory shutdown if the rectification did not meet the requirements.^[5]

Second, the municipal government is the enforcer of supervision and punishment. The corporates need to report monthly self-monitoring data to the Department of Environmental Protection of Nanjing (DEPN). DEPN examines the data, reports to DEEJ (if necessary), and then issues fines, criticism, or warning accordingly. Moreover, central and provincial teams only go into corporates two to three times a year, but DEPN conducts much frequent field inspections. During the visit, the officials and technicists inspect the production process, interview with front-line workers, and hold meetings with firm leaders. The officials are here to emphasize the importance of complying with regulations, while the technicists conduct inspections by themselves to verify the self-monitoring data provided by the firm.

One manager explained the profound influences of local environmental regulations on technological innovation.

The stringent policies of Jiangsu and Nanjing force us to keep upgrading our production measures. For example, even though we have developed products with less emission, they still emit something. But the Jiangsu government requires that if the company starts new projects with emission, the existing projects must reduce emission in double amount. We have to keep investing to find ways of reducing more emission even though we have met all the standards of central and local policies. On the other hand, we need to be prepared for the visits from Nanjing, Jiangsu, and the central inspection teams. We must not make any mistakes because being in the notice of criticism and warning exerts very negative influences on our reputation. What we cannot afford is not the fines but the damage of our image, especially when we are the leader and a renowned SOE in the sector.

Compared with the prescriptive standards made by the central government, the ones of the local governments have more direct effects on promoting the innovation of SYPC. The stricter and detailed nature of local regulations significantly drives SYPC’s technological innovation compared to central policies.

4.3 The Headquarters Level: The Performance Management Systems

The SINOPEC headquarters resembles the local governments in making environmental regulations. Their system rapidly processes and tailors central policies to align with the company’s objectives, with indicators stricter than central policies but different from local regulations. The indicators are modified to fit into the development plans of the company. For SYPC, the headquarters-level indicators for production are stricter than those of central policies, but the strictness is different from that of the Jiangsu Government. The headquarters considers more from a sectoral perspective and requires the company to outperform domestic and international competitors. The Jiangsu Government cares more about how to restrict emission but also to maintain a high level of production to both protect environment and promote development. The headquarters also sends teams to SYPC for patrol inspections with the similar intentions of DEPN.

Except similarities, the unique characteristic of the headquarters-level regulations is the performance management systems. Two systems saliently affect behaviours of branch companies. One is named HSE (the initials of health, safety, and environment) enacted in 2001.^[6] The ultimate goals of HSE were zero injury, zero accident, and zero pollution. HSE consisted of the safety performance index (SPI) and environmental performance index (EPI). EPI was based on different quantitative indicators such as the number of environmental emergencies and the amount of various pollutant emission. EPI and SPI of subsidiaries were calculated and evaluated by the headquarters. In 2018, HSE was upgraded into (the initials of health, safety of production, safety of public, and environment) in which the safety was refined into production safety and public safety. The other one is the green corporate action plan (GCAP) in 2018.^[7] The plan proposed six aspects of building a green corporate including green development, green energy, green production, green services, green technology, and green culture. Every aspect was quantified with several indicators and the evaluating procedure was the same as that of HSE. The results of these systems directly link to honorary titles, bonus, fines, and criticism, affecting the strategic position of the branch in the group company.

Besides stringent measures, the headquarters intends to motivate subsidiaries by creating a competitive environment. But the performance management is increasingly associated with extra quantified targets set by SYPC itself and becomes stressful. As one manager suggested:

We are determined to implement the HSSE and GCAP as the headquarters asks. The company (SYPC) set the plan to build the green corporate in 2018 with a specific schedule. Every stage was with a clear deadline and related staff needed to sign the letter of responsibility (ze ren zhuang) under the accountability system. There are monthly assessments of how well the systems are carried out. All the personnel in the company are under a grading system on how much they contribute to the systems that connects to individual performance evaluation. In this situation, all the aspects of SYPC, surely including technological innovation, have been extensively improved.

Performance management belongs to the flexible instrument, and according to the narrow version of the PH, it better motivates corporates to innovate than stringent policies. For the question about whether the performance management systems give greater incentives to innovate, the same manager said:

These systems cannot be separated from the standards of the headquarters and the government. Accomplishing those standards is the basic requirement, but is already very challenging. The systems are more like a reminder of the standards. On the other hand, a competitive environment indeed encourages innovation. For example, many of our staff took part in the contests for product design and production techniques held by the headquarters and achieved amazing performances that benefit both themselves and SYPC.

What this manager said reveals that the effects of stringent and flexible instruments on innovation intertwine with each other instead of being separated. The performance management is first to guarantee that emission standards from the government and headquarters are fulfilled, and then to gain extra innovation. Though the flexible instruments lead to extra incentives for and performance of innovation, the “more space” for managers and other employees is built on the pressure under realizing prescriptive standards (Arimura et al., 2007).

4.4 The Influences of Regulations on SYPC Performance

The multi-level regulatory measures significantly foster SYPC’s technological innovation, aligning with the company’s emphasis on social responsibility over profitability. One manager gave his explanation:^[8]

We are a renowned SOE. Earning profits is only a part of our goals. We have social responsibilities to create a better environment. We have made great achievement and won many national and local level honorary titles such as the ‘environmentally friendly corporate in China’. We also increase the investment in improving working conditions, salaries and welfare of our staff to promote their sense of happiness.

This manager seems to pay more attention to the social responsibility. Existing studies have suggested that for the managers of SOEs in China, the greater policy burden on them, the higher level of extra perks they can get (Jian et al., 2020). In contrast, they care less about the performance because they can use the policy burden as “an excuse” (Liao et al., 2009). These perspectives are to some extent reflected through what this manager said. SYPC has used money it earns to improve the environment and treatment of staff both emphasized by the government so that the net profits are limited. But implementing policy objectives for the environment indeed brings SYPC better performance according to another manager:

We have won many honorary titles that in fact benefit our performance. First, the government prioritizes corporates with more honorary titles and awards when it approves new projects. Second, a good reputation increases public recognition of the company important to our sale of products.

Based on the two managers in this subsection, implementing regulations promotes economic performance of SYPC but which cannot be reflected by the net profits because the company keeps investing in technology and welfare of the staff. Although this article does not have the access to the revenue of SYPC for verification, the view should be correct since the company maintains a mid-level of profitability whilst increasing other investments. The preferences by the government and the public are two ways of how following regulations helps with performance. It is important for corporates to gain the preference by the local government as it controls considerable natural, market, and political resources. For example, local governments profoundly influence local markets through SOEs in all industries (Broadman, 2001). For an industrial corporate, it is likely that its main business partners in the upstream and downstream industries are local SOEs. Financial institutions providing capital to the firm are primarily state-owned commercial banks. The company gains preferential treatment from the government for new projects and increased public recognition, both vital to its product sales. This alignment with regulations supports SYPC’s economic performance through government preference and public acceptance, emphasizing the company’s importance in the local market and its appeal to environmentally conscious consumers. Studies also suggest that a “green” reputation and acceptability by the public significantly affect economic performance of the corporate (Tang et al., 2012).

Table 2 shows the distinctive regulative levels for SYPC, their main characteristics, and important connected results.