Firms that are based in a city with high levels of air pollution have much lower efficiency when it comes to corporate investments, according to new research from Guanming He, Associate Professor in Accounting, and Tiantian Lin, from Beijing Jiaotong University.
The researchers found that air pollution adversely impacts managers’ mood, judgement, and decision-making on corporate investments, and thereby reduces the investment efficiency of firms. With the environment helping or hindering an economy by affecting the decision-making process at the c-suite, this research presents valuable learning opportunities for managers.
Data from the Air Quality Index (AQI) - constructed and published by the Ministry of Environment Protection of China in 2014 - compared recorded pollution levels to the financial, governance, and stock market data for 2,174 Chinese listed firms for the period 2014–2019.
The researchers not only found that air pollution reduces investment efficiency of firms, but it also exacerbates either over-investments or under-investments by a firm. Based on a sample of 10,920 firm-year observations for 2,174 firms headquartered in the 230 cities in China, they found that the degrees of inefficient investments, over-investments, or under-investments by firms located in the worse polluted cities are, on average, 7.6%, 8.6%, and 5.5%, respectively, higher than those located in the less polluted cities. The less (worse) polluted cities are defined as the cities that have the level of air quality higher (lower) than the sample median.
“As investment efficiency of a firm is lowered by air pollution, the firm might face shrinking profitability and deteriorating performance, losing their competitive advantage in the long term. Managers might also suffer, as their compensation and career prospects are often tied to the profitability and performance of their firms.”
However, the researchers discovered that a city’s green space coverage and humidity did not have direct impacts on firms’ investment efficiency. The study also explored whether other characteristics of Chinese firms, such as firm size, profits etc., had any impact on the efficiency of their investments in polluted areas. The researchers found that the negative impact of air pollution on firms’ investment efficiency is stronger for small firms, non-state-owned firms, financially constrained firms, and firms faced with high business risk or fierce industrial competition.
Two ways to mitigate the negative impact of air pollution:
For firms, this showcases that air pollution is a very clear barrier to being as efficient as possible in their important decision-making, and they should look into ways to alleviate this.
For policymakers, the researchers suggest their findings underscore the importance of reducing air pollution, such as enforcing related environmental policies, given the essential role of corporate investments in promoting a country’s economic growth.