Some twenty years ago, Harvard Business School economist and strategy professor Michael Porter challenged conventional wisdom about the impact of environmental regulation on business by declaring that well-designed regulation could actually enhance competitiveness. The traditional view of environmental regulation held by virtually all economists until that time was that requiring firms to reduce an externality like pollution necessarily restricted their options and thus by definition reduced their profits. After all, if profitable opportunities existed to reduce pollution, profit-maximizing firms would already be taking advantage of them. Over the past twenty years, much has been written about what has since become known simply as the Porter Hypothesis. Yet even today, we continue to find conflicting evidence concerning the Porter Hypothesis, alternative theories that might explain it, and oftentimes a misunderstanding of what the Porter Hypothesis does and does not say. This article examines the key theoretical foundations and empirical evidence concerning the Porter Hypothesis, discusses its implications for the design of environmental regulations, and outlines directions for future research on the relationship between environmental regulation, innovation, and competitiveness. (JEL:Q58, O38, F18)

Previous studies that attempt to relate environmental to financial performance have often led to conflicting results due to small samples and subjective environmental performance criteria. We report on a study that relates the market value of firms in the S&P 500 to objective measures of their environmental performance. After controlling for variables traditionally thought to explain firm-level financial performance, we find that bad environmental performance is negatively correlated with the intangible asset value of firms. The average "intangible liability" for firms in our sample is $380 million - approximately 9% of the replacement value of tangible assets. We conclude that legally emitted toxic chemicals have a significant effect on the intangible asset value of publicly traded companies. A 10% reduction in emissions of toxic chemicals results in a $34 million increase in market value. The magnitude of these effects varies across industries, with larger losses accruing to the traditionally polluting industries. © 2001 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology