Combating climate change and environmental degradation is one of the most urgent challenges of our time. Accordingly, many governments and international organisations, such as the OECD, the UN or the European Bank for Reconstruction and Development, have strengthened actions to accelerate a green economic transformation. Given that firms are responsible for a large fraction of global emissions and impact the environment in several ways, these organisations all emphasise the importance of greening the private sector.
To achieve a green economic transformation, firms must be aware of their environmental footprint and need to take the consequences of their production on the environment into consideration. To this end, a firm’s capability to monitor and manage actions related to greening its production is central. This requires, among other things, management practices targeted at greening the firm.
However, implementing green management practices is costly and depends on specific knowledge. Attracting foreign direct investment (FDI) might serve to overcome these constraints. Beyond financial resources, foreign ownership can accelerate the diffusion of knowledge and advanced organisational structures. In addition, multinational firms face a broader set of stakeholders and, therefore, experience more external pressure to green their production.
Nevertheless, there are widespread concerns that multinational firms might exploit lower environmental regulations abroad by outsourcing resource-intensive production steps. This is commonly known as the ‘pollution haven’ effect. Many researchers have analysed firm-level data to better understand the drivers of firms’ environmental performance. Notably, these studies commonly do not find support for the pollution-haven effect and even point to a relatively cleaner production of foreign-owned firms compared to domestic ones.
Such positive effects of FDI on the environment are known as the ‘halo effect’. For instance, recently published research reveals that compared to domestic firms, foreign-owned firms are more likely to implement measures related to environmental improvements and that firms that have been acquired by foreign investors are more productive, which in turn can result in lower intensity of waste carbon production. Improvements in management practices serve as a key explanation for this observation. In line with this, the pace of a green transformation of firms might crucially depend on management practices that are particularly targeted at greening of the production and climate change-related aspects. In our research, we shed light on the relation between green management practices, firms’ environmental performance, and foreign ownership.
Better environmental performance
Green management practices capture whether a firm has a green strategy or has a green manager responsible for environmental and climate change issues. We find that firms with green management practices in place show better environmental performance, indicated by higher adoption rates of green innovations. These capture, for instance, the introduction of recycling and waste management, air pollution control measures or energy management. Accordingly, the adoption of green management practices is not just a form of signalling goodwill to stakeholders’ demand for sustainable production.
Having green management practices in place
We argue that foreign ownership supports firms to tackle constraints preventing them from introducing green management practices. Foreign-owned firms are indeed more likely to have green management practices implemented. Figure 1 illustrates the differences in the shares of firms with a green strategy and a green manager between firms with and without foreign ownership located in 28 countries from north Africa, eastern Europe and Asia.
Figure 1: Differences in green strategy and green manager between firms with and without foreign investment
It reveals that foreign ownership links to higher rates of green management practices. Among foreign-owned firms in our sample, 31.1% have a green strategy and 23.5% have a green manager, whereas among domestic firms only 14.8% have a green strategy and less than 10% have a green manager.
Even though these shares point to big differences, it is important to consider that foreign-owned and non-foreign-owned firms differ in several other characteristics. For instance, multinational firms are generally larger and foreign investors might ‘cherry pick’ productive firms when investing abroad. To isolate the effect of foreign ownership from other firm characteristics, we compared foreign and domestic firms that are similar. Once such differences are controlled for, we find that firms with foreign ownership are, on average, about 1.3 times more likely to have a green strategy and 1.2 times more likely to have a green manager compared to domestic firms.
Generally, the revealed patterns are more pronounced — both in terms of magnitude and statistical significance — for the adoption of a green strategy compared to having a green manager. This can be explained by the role of headquarters and the international standardisation of firms’ processes. A green manager is an additional cost factor and foreign firms might prefer to have only one. A green strategy, however, is easier to implement and easier to supervise.
Further, the revealed relation between foreign ownership and green management practices differs by industry. Foreign-owned firms in the manufacturing sector are more likely to have green management practices compared to firms with foreign ownership in the service sector. These results can be explained by the fact that manufacturing sector firms are, in general, more centrally organised and firms’ headquarters have relatively stronger control in manufacturing sector firms. So far, the patterns shown are average effects for firms located in countries at very different stages of economic development.
FDI vs green management practices
Usually, countries’ environmental regulations and performances improve with development. In line with this, it is likely that differences in the predicted relation between green management practices and foreign ownership depend on the income level of the country where a firm is located. Theoretically, firms in less developed economies, which are generally less competitive in terms of access to a skilled labour force or state-of-the-art technology, might particularly benefit from FDI. However, we find that the positive effect of FDI on green management practices is more pronounced in relatively more advanced economies and not detectable for firms in relatively less developed economies. Figure 2 shows the effect of FDI on the probability of having a green strategy depending on the level of development measured by gross national income per capita.
Figure 2: Effect of FDI on probability of having a green strategy, depending on level of development
While the effect is almost zero for lower-middle-income (LM) countries, it turns positive and significant for some upper-middle-income (UM) countries and increases to 5–15 percentage points for high-income (H) countries.
The latter effect points to a possible environmental premium of European integration, because the relatively more advanced economies under investigation are EU countries in eastern Europe, such as Poland, Estonia and the Czech Republic. Firms in these countries seem to derive a disproportionate environmental benefit from foreign ownership. Conversely, firms in lower-middle income countries, such as the Kyrgyz Republic, Morocco or Uzbekistan, do not seem to have this environmental benefit from foreign ownership.
This pattern can be explained by differences in environmental regulations and capacities in the host countries. Regulations and other characteristics in the source country of FDI are also likely to play a role. For example, FDI in eastern European countries originates, to a large extent, from other European countries being subject to relatively stringent environmental regulations and with strong stakeholder pressure.
Green gifts from abroad
Recent research indicates that foreign ownership positively relates to firms’ environmental performance. Our findings highlight a crucial mechanism for this relation, namely that foreign-owned firms are more likely to have green management practices in place, which in turn translate into cleaner production.
Overall, we conclude that FDI can accelerate the green transformation of the private sector. However, the finding is not observable for firms in less developed economies. Accordingly, complementary measures, such as strengthening institutions and tightening environmental regulations, remain crucial for countries’ green transformation and determine the relation between foreign ownership and green management practices.
Peter Kannen is a researcher at the Helmut Schmidt University Hamburg. Finn Ole Semrau and Frauke Steglich are researchers at the Kiel Institute for the World Economy.
This article is based on Kannen P, Semrau FO & Steglich F. 2021. Green gifts from abroad? FDI and firms’ green management. Kiel Working Paper No. 2200
This article first appeared in the February/March 2022 print edition of fDi Intelligence. View a digital edition of the magazine here.