The Porter Hypothesis: Fact or Myth? - A Case Study on the EU Emissions Trading System

Abstract: This study investigates the Porter Hypothesis in the context of the EU Emissions Trading System (EU ETS), the world's largest cap-and-trade system within environmental regulations. The Porter Hypothesis posits that environmental regulations can stimulate eco-innovation and ultimately improve the financial performance of regulated firms. To estimate the causal effects of the EU ETS on eco-innovation and firm performance, this study employs a matched Difference-in-Difference and mediation analysis. Through Propensity Score Matching, the study matches firms subject to regulation with statistically comparable non-regulated firms. The results provide support for the Weak form of the Porter Hypothesis, indicating that the EU ETS has induced eco-innovation among regulated firms. The EU ETS framework, which progressively increases in stringency across phases, has further facilitated the increased green technology innovation for all firms in regulated sectors. However, similar to previous studies on the Strong variant of the Porter Hypothesis, this study does not find support for regulation having an impact on firm performance. This thesis finds that the conditions required for the Strong variant to hold are perhaps outdated, and therefore concludes it is time to debunk this strand. Furthermore, the study provides important implications for EU policymakers concerning the prices in the carbon market and the future of the EU ETS. Overall, this study sheds light on the efficacy of the EU ETS in promoting eco-innovation and environmental regulation's role in firm performance.