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Formation and political consequence of environmental enforcement policy : evidence from the US industries Sun, Meng 2010

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Formation and Political Consequence of Environmental Enforcement Policy Evidence from the US Industries by Meng Sun B.A., The Jilin University, 2000 M.Phil., The Hong Kong University of Science and Technology, 2001 A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF DOCTOR OF PHILOSOPHY in The Faculty of Graduate Studies (Economics) THE UNIVERSITY OF BRITISH COLUMBIA (Vancouver) October 2010 c© Meng Sun 2010 Abstract This thesis investigates the determinants and political consequences of envi- ronmental enforcement policy. Three related issues are addressed using the U.S. manufacturing data at the industry level. In Chapter Two, I estimate the elasticity of the violation rate with re- spect to the inspection rate for the manufacturing industries. This elasticity reflects the power of monitoring to alter an industry’s violation status. I con- duct an estimation of the relationship between the violation rate and the inspection rate at the industry level, but the specification is based on an individual firm’s dichotomous choice in a logit model. The inspection rate is instrumented with the average of the inspection rates across the other indus- tries that belong to the same sector to deal with the endogeneity problem. I find a substantial variation in the elasticity of the violation rate across industries. Chapter Three addresses how the inspection rate is determined by the elasticity of the violation rate when the enforcement agency is constrained with a hard monitoring budget. Given the limited monitoring resources, an enforcement agency targets industries where inspections are more likely to be effective in reducing violations to reduce inefficiency, all else equal. Empirical results confirm the positive effect from the absolute elasticity on the inspection rate. But the magnitude of this effect is conditional on the pollutants’ damage level to the environment. In Chapter Four, I focus on the political consequence of the enforcement policy. I employ the campaign contribution presented to the Congress exclu- sively for environmental issues (EPC) to measure the environmental political activity. The variation of EPC across industries is explained by the enforce- ment policy stringency. Although the EPC presented to the Congress is ii Abstract targeted directly on environmental regulation rather than the enforcement policy, a stricter enforcement policy increases the marginal benefit from contributing the congress for relaxing the regulation. Empirically, I use the elasticity of the violation rate to isolate the effect of the enforcement policy on EPC. An industry with a larger elasticity of the violation rate is more likely to face a higher inspection rate, it therefore is more likely to engage in the political activity. iii Table of Contents Abstract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ii Table of Contents . . . . . . . . . . . . . . . . . . . . . . . . . . . . iv List of Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v List of Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vi Acknowledgements . . . . . . . . . . . . . . . . . . . . . . . . . . . vii Dedication . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . viii 1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2 Estimating the Elasticity of the Violation Rate at the In- dustry Level . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 2.2 Econometric model of the industry-level violation rate . . . . 8 2.2.1 Individual firm’s welfare . . . . . . . . . . . . . . . . 8 2.2.2 Industry-level violation rate function . . . . . . . . . 9 2.3 Empirical specification . . . . . . . . . . . . . . . . . . . . . 11 2.3.1 Endogeneity of enforcement policy . . . . . . . . . . . 11 2.3.2 Endogeneity of emission intensity . . . . . . . . . . . 12 2.3.3 Elasticity of violation . . . . . . . . . . . . . . . . . . 13 2.4 Data sources and variables . . . . . . . . . . . . . . . . . . . 14 2.4.1 Measuring compliance behavior and enforcement pol- icy . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 iv Table of Contents 2.4.2 Other variables . . . . . . . . . . . . . . . . . . . . . 15 2.5 Empirical results . . . . . . . . . . . . . . . . . . . . . . . . . 20 2.6 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 3 The Formation of Environmental Enforcement Policy: Evi- dence from the U.S. Industry-level Data . . . . . . . . . . . 25 3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 3.2 A simple theoretical model - enforcement with heterogeneous industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 3.3 Empirical specification and data . . . . . . . . . . . . . . . . 33 3.3.1 The inspection rate equation . . . . . . . . . . . . . . 33 3.3.2 Endogeneity of the emission intensity . . . . . . . . . 35 3.3.3 Data description . . . . . . . . . . . . . . . . . . . . . 36 3.4 Empirical results . . . . . . . . . . . . . . . . . . . . . . . . . 42 3.5 Robustness and sensitivity analysis . . . . . . . . . . . . . . 44 3.6 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 4 Determinants of Environmental Political Contribution . . 48 4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 4.2 Theoretical perspective . . . . . . . . . . . . . . . . . . . . . 55 4.3 Descriptive analysis of environmental political contribution . 58 4.3.1 Measuring environmental political activity . . . . . . 58 4.3.2 Trend analysis . . . . . . . . . . . . . . . . . . . . . . 60 4.4 Empirical specification and data sources . . . . . . . . . . . . 62 4.5 Empirical results . . . . . . . . . . . . . . . . . . . . . . . . . 71 4.6 Robustness checks . . . . . . . . . . . . . . . . . . . . . . . . 73 4.7 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78 Appendices A Appendix to Chapter 2 . . . . . . . . . . . . . . . . . . . . . . 87 A.1 The BLP model . . . . . . . . . . . . . . . . . . . . . . . . . 87 v Table of Contents A.2 Econometric model of the industry-level violation rate . . . . 88 A.3 Data of the inspection rate and the violation rate . . . . . . 89 A.4 First stage results of 2SLS in Table 2.3 . . . . . . . . . . . . 91 B Appendix to Chapter 3 . . . . . . . . . . . . . . . . . . . . . . 92 B.1 Proof of equation 3.4 . . . . . . . . . . . . . . . . . . . . . . 92 B.2 Risk-screening environmental indicators . . . . . . . . . . . . 92 C Appendix to Chapter 4 . . . . . . . . . . . . . . . . . . . . . . 94 C.1 Background . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 C.2 Data of environmental political contribution . . . . . . . . . 97 C.2.1 Members of key House/Senate environmental commit- tee/subcommittee . . . . . . . . . . . . . . . . . . . . 97 C.2.2 Campaign contribution . . . . . . . . . . . . . . . . . 98 C.2.3 SIC code . . . . . . . . . . . . . . . . . . . . . . . . . 98 C.2.4 Data summary . . . . . . . . . . . . . . . . . . . . . . 99 vi List of Tables 2.1 Variable Definition and Data Sources I . . . . . . . . . . . . . 18 2.2 Summary Statistics I . . . . . . . . . . . . . . . . . . . . . . . 19 2.3 Second-Stage Results of Violation Rates Regressions (2003’- 2005’) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 2.4 Industries Ranked by the Estimated Elasticities of the Viola- tion Rate (111 Industries) . . . . . . . . . . . . . . . . . . . . 22 3.1 Variable Definition and Data Sources II . . . . . . . . . . . . 40 3.2 Summary Statistics II . . . . . . . . . . . . . . . . . . . . . . 41 3.3 Inspection Rates Regressions . . . . . . . . . . . . . . . . . . 45 3.4 Robustness of Inspection Rates Regressions . . . . . . . . . . 47 4.1 Environmental Political Contribution to Congressional Can- didates (124 Industries in Manufacturing Group) . . . . . . . 61 4.2 Industries in Manufacturing Group Ranked by Environmental Political Contribution Amounts, 2005-2006 . . . . . . . . . . 63 4.3 Variable Definition and Data Sources III . . . . . . . . . . . . 69 4.4 Summary Statistics III . . . . . . . . . . . . . . . . . . . . . . 70 4.5 Results of Environmental Political Contribution Intensities Regressions: Election Cycles of 2000, 2002, 2004 and 2006 . . 74 4.6 Robustness of Environmental Political Contribution Intensi- ties Regressions . . . . . . . . . . . . . . . . . . . . . . . . . . 76 A.1 Comparision with the BLP Model . . . . . . . . . . . . . . . 88 vii List of Tables B.1 Industries at the Four-Digit SIC Level Ranked by Average Values of the Damage Indicator over 2003’-2005’ (410 Indus- tries) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 C.1 Selected Vote Description . . . . . . . . . . . . . . . . . . . . 95 viii List of Figures 4.1 The Variation of the EPC Intensity . . . . . . . . . . . . . . . 49 ix Acknowledgements I woulk like to show my deep gratitude to my thesis supervisor, Prof. Brian Copeland. His continuing guidance and support with great patience enabled me to have stumbled forward a little on the research path. This thesis would not have been possible without his help. Prof. Werner Antweiler, Prof. Matilde Bombardini and Prof. Summet Gulati provided valuable comments that led to substantive improvements. Their input has been appreciated. I am also grateful to Prof. John Hartwick for his comments at the 2006 Canadian Economics Association Annual Meeting, and all those who helped me to complete this thesis. x Dedication To my parents, Qichun and Siyi xi Chapter 1 Introduction The enforcement of environmental legislation is crucial to achieving desir- able environmental outcomes. This thesis explores the determinants and consequences of the environmental enforcement policy. Specifically, I ad- dress the following three questions using the U.S. manufacturing data: (1) How do industries react to a change in environmental enforcement policy? (Chapter Two) (2) How is the environmental enforcement policy determined at the industry level? (Chapter Three) (3) How does the environmental en- forcement policy affect an industry’s political activity that is designated for environmental issues? (Chapter Four) In Chapter Two, I estimate the elasticity of the violation rate with re- spect to the inspection rate for industries in the manufacturing group. This elasticity reflects the power of monitoring to alter an industry’s violation status and is regarded as an industry characteristic. I conduct an estima- tion of the relationship between the violation rate and the inspection rate at the industry level, but the specification is based on individual firm’s di- chotomous (violation/compliance) choice in a logit model. The potential endogeneity problem of the inspection rate is dealt with by using an instru- ment, which is the average of the inspection rates across the other industries that belong to the same sector. I find a substantial variation in the elasticity of the violation rate across industries. This estimated elasticity is employed to investigate its role in determining the environmental enforcement policy in Chapter Three. The elasticity could be fundamental to the making of environmental enforcement policy when an enforcement agency has limited monitoring resources. In the United States, the Environmental Protection Agency (EPA) explicitly faces a hard budget constraint in monitoring firms to make sure they abide by environmental 1 Chapter 1. Introduction regulatory policies such as the standard and the emission limit. Each year, the EPA develops a proposed budget defining the funding for the goal of compliance and related priorities. Then, the Congress passes bills to enact amended budgets into law.1 For example, the FY (fiscal year) 2010 Budget includes approximately $600 million for EPA’s Enforcement and Compliance Assurance program, and a $32 million increase over the FY 2009 Enacted level. In particular, for the Agency’s Compliance Monitoring program2, in FY 2010, its proposed budget is $101.1 million. FY 2010 Compliance Monitoring activities will be both environmental media- and sector-based.3 Given the limited monitoring resources, an enforcement agency targets industries where inspections are more likely to be effective in reducing viola- tions to reduce inefficiency, all else equal. This implies the important role of the elasticity of the violation rate in determining the inspection stringency. I develop a simple model where the regulator faces a hard budget constraint for its inspection and enforcement activities. If the agency maximizes social welfare subject to this constraint, the model predicts that the inspection rate will be higher in those industries with a higher elasticity of the viola- tion rate with respect to the inspection rate. Empirical results confirm a positive effect from the absolute elasticity on the inspection rate. But the magnitude of the effect of the elasticity of the violation rate is conditional on the pollutants’ damage level to the environment. In Chapter Four, I focus on the political consequence of the environmen- tal enforcement policy. I first construct an index of environmental political contribution (EPC) – the campaign contribution presented to the Congress exclusively for environmental issues, which serves as the direct evidence of political pressure on the environmental regulations – to measure the environ- mental political activity. Then, I explore the role of the enforcement policy stringency in explaining the variation of the EPC across industries. In a 1See details in the U.S. EPA website: http://www.epa.gov/ocfo/budget/. 2This Compliance Monitoring program reviews and evaluates the activities of the reg- ulated community to determine compliance with applicable laws, regulations, permit con- ditions and settlement agreements, and to determine whether conditions presenting im- minent and substantial endangerment exist. (FY2010 EPA Budget in Brief, U.S. EPA.) 3Source: FY2010 EPA Budget in Brief, U.S. EPA. 2 Chapter 1. Introduction multi-agent system, the environmental legislation/regulation is determined by the Congress, but the enforcement policy is set by the EPA4. Although the EPC presented to the Congress is targeted directly on environmental legislation/regulation rather than the enforcement policy, the enforcement policy affects the marginal benefit from contributing to the congress for re- laxing the legislation/regulation. For example, for an industry with a higher inspection rate (which represents a stringent enforcement policie), its iden- tified pollution amount is larger. This implies that this industry pays more pollution taxes than the industry with a lower inspection rate at the same pollution tax rate. One unit relaxation of the pollution tax rate (which represents an environmental regulation) after the congress receives certain political contribution amount brings more benefits (a larger reduction in pol- lution tax payment) to this industry. Therefore, industries facing stricter enforcement policies are more likely to engage in the political activity all else equal. There are two features in the empirical examination. First, I employ EPC to characterize the environmental political activity. This is in contrast to existing works that use total political campaign contributions which may be the result of multiple purposes. Second, I use the elasticity of the viola- tion rate to infer the effect of the enforcement policy on the environmental political contribution. This is because an industry with a larger elasticity of the violation rate is more likely to face a higher inspection rate, as shown in Chapter Three. The reason that I do not use the enforcement policy as a regressor directly is to distinguish the effect of the environmental en- forcement policy from that of the environmental regulation. Although the enforcement policy and the environmental policy are determined by sepa- rate agencies, the two kinds of policies have many common determinants (e.g., the emission intensity). If the relationship between the enforcement policy and the environmental political contribution arises as a result of these 4In the U.S., environmental enforcement takes place in the context of a system (the environmental federalism) consisting of local and state jurisdiction and the Federal en- forcement agency. Because this work focuses on the variation across industries instead of that across regions, I partly control for the role of the state and local communities with the geographical concentration variable and focus on the role of EPA. 3 Chapter 1. Introduction common determinants, it is hard to isolate the enforcement policy’s effect. I find a positive relationship between the absolute elasticity of the violation rate and the EPC. The results are consistent with the predictions. In sum, this thesis joins the literature on the monitoring and enforce- ment of environmental policy with that on the political formation of eco- nomic policy. The rest of the thesis is organized as follows: Chapter Two empirically investigates environmental policy’s deterrence effect on firms’ compliance behavior and estimates the elasticities of the violation rate with the inspection rate at the industry level. Chapter Three develops a simple model to explain the variation of environmental enforcement policy when the enforcement agency is constrained with a hard budget. The predictions are empirically examined. Chapter Four provides a descriptive analysis of EPC, focuses on the amounts that industries contribute and uncovers the pattern of environmental political action across industries. 4 Chapter 2 Estimating the Elasticity of the Violation Rate at the Industry Level 2.1 Introduction How do industries react to the changes in environmental enforcement pol- icy? Evidence from industry studies suggests that there is variation across industries in the response of the violation rates to inspections. For example, Gray and and Shadbegian (2005) find that pulp mills are less sensitive to in- spections than paper mills. This is not surprising because heterogeneities in abatement costs and other industry characteristics are likely to affect viola- tion rates. However, to date there has not been a systematic cross-industry analysis of how violation rates respond to inspections. This chapter estimates the elasticity of an industry’s violation rate with respect to its inspection rate. This elasticity reflects the power of monitoring to alter an industry’s violation status. It is fundamental to the design of en- vironmental enforcement policy.5 When an enforcement agency has limited monitoring resources (economically or politically), it can target industries where inspections are more likely to be effective in reducing violations to reduce inefficiency (all else equal). The next chapter (Chapter three) in- vestigates how the elasticity of the violation rate plays a role in allocating the monitoring resources across industries for an enforcement agency. The 5This estimation of the elasticities is also useful for the policy’s effectiveness evaluation and environmental consequence forecasting. 5 2.1. Introduction estimates from this chapter will play a key role in that analysis. The estimation of the elasticities for all industries is still absent in the literature. Existing works focuses on certain industries (e.g. pulp/paper6/oil spills) and estimate the effectivess of the enforcement policy on firms/plants/facilities within the industries (Magat and Viscusi, 1990; Earnhart 2004a, 2004b; Shimshack and Ward, 2005, 2008; Laplante and Rilstone, 1996; Gray and Deily, 1996; and Telle, 2009). I conduct an estimation at the aggregate level (using the industry-level data) but the specification is based on individ- ual firm’s dichotomous (violation/compliance) choice using a logit model. I thus avoid having to collect the data of firm characteristics for all industries, which is difficult. This chapter applies the BLP demand function estimation technique (Berry, Levinsohn, & Pakes, 1995). Each firm is a rational economic decision- maker who violates its effluent standard when the net benefit of doing so exceeds that of compliance. Each firm’s welfare is determined by the reg- ulatory policies imposed on violating/complying firms and individual firm characteristics. Within each industry, firms are subject to the same com- pliance/violation policies, such as the unit penalty for violation, and the minimum unit abatement investment for compliance. In this work, the en- forcement policy I consider is the inspection rate. Individual firm character- istics are idiosyncratic ones across firms, such as the abatement efficiency, the production technology, and the managers’ preferences. I assume the individual firm characteristics follow an i.i.d. logit draw. Given the inspec- tion rate imposed on violating firms, the probability of choosing violation is modelled as a realization from the logit distribution with the firm character- istics. I assume further that there are infinitely many firms in each industry. Then, this logit probability can be regarded as the industry violation rate, depending on the policy – the inspection rate. In order to facility the em- pirical estimation, I incorporate an outside alternative choice (the shutdown choice). It can be deived that the difference between the logarithm of the 6Nadeau (1997) focuses on air pollution, and estimates the elasticity of the violation time with respect to the EPA monitoring activity for the pulp and paper industry which is between -0.4 and -0.47. 6 2.1. Introduction violation rate and that of the shutdown rate (the log odds ratio) is a linear function of the inspection rate at the industry level. This approach allows me to apply the linear instrumental variable (IV) approach to combat the endogeneity problem. This endogeneity problem arises when there may exist a reverse causality from the violation rate to the inspection rate. The instrument of the inspection rate I use is the av- erage of the inspection rates across the other industries7 that belong to the same sector8. The instrument is highly correlated with the inspection rate because they pick up common government-regulation shocks (e.g. a bud- get cut). Meanwhile, the instrument is uncorrelated with the unobserved industry-specific factors. In the literature at the disaggregate level, some ignore the endogeneity problem (e.g. Gawande and Wheeler, 19999). For others, there are two types of instruments10 used. But the employment of these two different instruments may lead to opposite results about the en- forcement policy’s deterrent effect: “models using lagged regulatory activity continue to find a negative impact of enforcement on compliance, while models using predicted activity yield positive coefficients, which regulatory activity increasing compliance” (Gray and Shadbegian, 2005).11 Empirically, I construct the industry-level inspection rate (proxying the enforcement policy) and the industry-level violation rate (proxying the pol- lution noncompliance level) using data from “Enforcement & Compliance History Online (ECHO)” provided by the U.S. Environmental Protection 7At the 4-digit SIC level. 8At the 2-digit SIC level. 9Gawande and Wheeler (1999) addresses the need to improve efficiency in governmental organizations. It analyzes the Maritime Safety Program of the U.S. Coast Guard, which is responsible for monitoring the quality of vessels that sail in U.S. waters, and present measures of effectiveness for the Program. The estimation is based on a Poisson regression model. 10When policy is regarded to be targeted on individual firm’s behavior, the effect of enforcement policy on firm’s compliance may encounter reverse causality problem. This can be directly alleviated with instrument variables such as the lagged policy (Magat and Viscusi, 1990; Earnhart 2004a, 2004b; Shimshack and Ward, 2005, 2008) or predicted policy probabilities (e.g., Laplante and Rilstone, 1996; Gray and Deily, 1996; and Telle, 2009) or both (Gray and Shadbegian, 2005). 11The other reason that I do not use the lagged value of the inspection rate as the instrument is that the time series is very short (three years). 7 2.2. Econometric model of the industry-level violation rate Agency (EPA). I find that the inspection rates significantly reduce the industry-level violation rates after the endogeneity problem of inspection rate is overcome with the IV approach. The elasticities of the violation rate with respect to the inspection rate at the industry level are calculated, which vary greatly between inspection “elastic” industries (e.g., 1865 and 3313) and inspection “inelastic” industries (e.g., 3845 and 3661). The mean value of the elasticity is about -0.34, implying that a 10% increase in the inspection rate yields a 3% reduction in the violation rate. The rest of the chapter is organized as follows. In Section 2.2, I derive the industry-level violation rate function for estimation based on the BLP econometric model. In Section 2.3, I discuss how to deal with some econo- metric issues and present the empirical specification. Section 2.4 describes the data sources and the construction of the variables. Empirical results are presented in Sections 2.5. Section 2.6 concludes. Appendices A contains proofs, data descriptions and the first stage results of the two-stage least square (2SLS) regressions. 2.2 Econometric model of the industry-level violation rate This section employs the BLP econometric model (Berry, Levinsohn, and Pakes, 1995)12 to derive the industry-level violation rate function. 2.2.1 Individual firm’s welfare There are infinitely many heterogeneous firms in a polluting industry and each firm makes choices between violation and compliance. Each firm’s welfare is determined by choice (compliance vs. violation) characteristics and individual firm characteristics. The equation for each firm’s welfare denoted by Fljt can be specified as Fljt = Rjt + ξjt + γljt 12See Appendix A.1 for details. 8 2.2. Econometric model of the industry-level violation rate where the subscript l represents firms, j ∈ (c=compliance, υ=violation) is the choice index, and t is the time index in years. Rjt and ξjt represent the characteristics of choice j that may affect wel- fare Fljt. That is, they do not vary across firms that make the same choice within an industry. Specifically, Rv is the enforcement policy imposed by the regulator on firms in violation, such as the unit violation penalty or inspection rate13; Rc is the regulation that a complying firm has to meet, such as the minimum unit abatement investment. ξv represents unobserved sources of welfare resulting from violation (e.g. pollution disutility to vi- olating firms’ own employees); ξc represents unobserved characteristics for firms in compliance (e.g. a good reputation with their consumers and the community). Besides unobserved choice characteristics, ξjt may also capture violation/compliance shocks in an industry14 or measurement errors. The last term, γljt, contains the characteristics of individual firm l that affect welfare Fljt, such as the input amount, the abatement technology and the manager’s preference. 2.2.2 Industry-level violation rate function When γljt is assumed to follow an i.i.d. logit draw, Wjt = Rjt + ξjt can be regarded as the mean welfare from choice j in year t in industry i. Violation is chosen whenever it leads to a higher welfare than compliance, that is, Flvt > Flct. Given any welfare in violation Flvt, the proportion of firms that choose to violate in industry i is the following according to γc’s density function, Pri,lv = Pr(Flvt > Flct) = Pr(γlct < Wvt −Wct + γlvt) = e−e −(Wvt−Wct+γlvt) Since the welfare in violation Flvt is random, characterized by the i.i.d. 13This increases violating firms’ cost because more violations would be identified as firms are inspected more often. 14For example, the price of an industry-specific abatement equipment that prevents firms from violation becomes higher. Because this price may enter the welfare function of choosing compliance only, the welfare of choosing violation is not affected as much as the welfare of choosing compliance. And this is a shock common to all firms in this industry. 9 2.2. Econometric model of the industry-level violation rate logit distribution of γv, the violation rate of industry i is the following,∫ ∞ −∞ Pr(Flvt > Flct)e−γlvte−e −γlvtdγlvt = 1 e−(Wvt−Wct) + 1 = eWvt eWct + eWvt Proof. See Appendix A.2. The desirable property of this logit probability (the violation rate, V R) is as follows. The numerator is the exponential function to the power of the welfare of this choice; the denominator is the sum of the exponential functions over all alternative choices. The implication is that the aggregate violation rate at industry level depends on the difference of the welfares, Wvt −Wct, instead of individual firm characteristics. Then, I add an outside alternative that is the shutdown of the facility and normalize the welfare of this alternative choice to zero. According to the property shown above, this implies that the violation rate is V Rit = eWvt 1 + eWct + eWvt and the closing firm share is Closeit = e 0 1+eWct+eWvt . Intuitively, the violation rate is the probability that the choice of violation has a higher welfare than the choices of compliance and the shutdown of the facility. Taking logarithms of the two equations and canceling out the denomi- nator ( 1 + eWct + eWvt ) that can not be controlled for, I have lnV Rit − lnCloseit = Rivt + ξivt (2.1) This allows us to consider a linear relationship between the logarithm of the violation rate, lnV Rit, and the enforcement policy on violating firms, Rivt, at the industry level. 10 2.3. Empirical specification 2.3 Empirical specification The following empirical specification based on equation (2.1) is established, lnV Rit − lnCloseit = β0 + β1IRit + β2 lnEIit + β3HHIit + β4DIit +β5 lnEMPit + β6GCit +G+ Y + ξit (2.2a) where i is the industry index, t is the time index, V Rit is the industry-level violation rate representing the degree of environmental non-compliance, and IRit is the industry-level inspection rate proxying the enforcement policy for violation (i.e., Rivt in equation (2.1)). The general industry conditions to be controlled for include the following: lnEI: the natural log of the level of emission intensity HHI: the Herfindahl-Hirschman Index measuring the concentration of firms in an industry (industry concentration) DI: “diverse industry” is a measure describing the number of different segments in which a firm operates EMP : the number of paid employment as a measure of industry size GC: “geographic concentration” describes the dispersion of firms ac- cording to their locations. In addition, I also add an election year dummy Y and a group dummy G (Group 2 or 3) to control for the election year effect15 and the group fixed effect respectively. β′is are coefficient scalars, and ξ is zero-mean error term. 2.3.1 Endogeneity of enforcement policy When estimating the effect of the inspection rate on the violation rate using the specification above, I adopt the IV approach to overcome the poten- tial endogeneity problem of the inspection rate. This endogeneity problem arises because the violation rate may have an influence on the choice of the 15In List and Sturm (2006), it is argued that the incumbent finds it worthwhile to manipulate the environmental policy to attract additional votes to his platform. Evidence of this effect of electoral incentives on environmental policy is shown in that work. 11 2.3. Empirical specification inspection rate by the enforcement agency as shown below, IRit = ϕ0 + ϕ1V Rit + ϕ2controls2 + eit (2.2b) In addition, the endogeneity problem of inspection rate may arise if there are unobserved variables (e.g., local political factors) that influence the industry-level violation rate and are correlated with the inspection rate. In order to produce unbiased estimated coefficients, I choose valid in- struments for IR. The instrument of the inspection rate is the average of the inspection rates across the other 4-digit industries that belong to the same 2-digit sector. For example, there are three industries “2111”, “2131” and “2141” at the 4-digit level in the 2-digit sector of “21” in the dataset. The instrument for the inspection rate of “2111” is the average of the in- spection rates of “2131” and “2141”. The instrument is highly correlated with the inspection rate. This is because they pick up common government- regulation shocks. For example, when an enforcement agency’s budget is reduced, the inspection rates across all industries in a sector are expected to be lower. Meanwhile, the instruments are uncorrelated with the unob- served industry-specific factors (e.g., the greater community pressure as a result of an pollution accident or an abatement technology improvement in this 4-digit industry) in the violation rate equation (2.2a) and those in the emission intensity equation (2.2c) below. 2.3.2 Endogeneity of emission intensity For the emission intensity, I employ a reduced-form specification in equation (2.2c) to show its potential endogeneity problem. lnEIit = γ0 + γ1IRit + γ2 lnwit + γ3 ln kit + γ4 lnMaterialit +γ5 lnEnergyit + γ6 (controls) + ϕit (2.2c) where EI is the emission intensity, IR is the inspection rate, w is the labor share, k is the capital share, Material is the material share, Energy is the energy share, and (controls) include other industry characteristics. 12 2.3. Empirical specification Equation (2.2c) links EI to the enforcement policy (IR) and input shares of production. This specification is motivated by Hettige et al. (2000) [43]: “The marginal cost of abating pollution from industrial sources is a function of the scale of activity, pollutant concentration in process influent, the degree of abatement, and local input prices”. The endogeneity problem of EI could arise when the error term in equa- tion (2.2a), ξ, is correlated with the error term in equation (2.2c), ϕ. On the one hand, V R could have an effect on EI through IR based on Equations (2.2b) and (2.2c). On the other hand, some unobserved violation character- istics or shocks may affect the emission intensity. This is because both the violation rate and the emission intensity are aggregated outcomes of firms’ problems at the industry level. As shown above, the full model is supposed to be a simultaneous equa- tion system that consists of equations (2.2a), (2.2b), and (2.2c). However, in this chapter, I only estimate the first equation. Specifically, I adopt the 2SLS estimation: (i) inspection rates and emission intensities are regressed on the instruments of inspection rates, input shares and other exogenous variables to obtain their predicted values respectively; (ii) I estimate Equa- tion (2.2a) with both the predicted emission intensity and the predicted inspection rates. 2.3.3 Elasticity of violation Last, I discuss the calculations of the marginal effect of the inspection rate on the violation rate and the elasticities of the violation rate with respect to the inspection rate. The marginal effect depends on the estimated coefficient β1 and the violation rate16: ∂V Ri ∂IRi,vt = ∂ e β1IRi,vt+ξivt 1+eλIRi,ct+ξict+eβ1IRi,vt+ξivt ∂IRi,vt = V Ri (1− V Ri)β1 (2.3) Because the violation rate is not larger than 1, the calculated marginal effect is negative as long as the estimate of β1 is negative. A negative 16Please see the appendix A.2 for proof. 13 2.4. Data sources and variables marginal effect implies a deterrent effect of the inspection rate. Further derivation provides the elasticity estimates as follows, ei = ∂V Ri ∂IRi,vt IRi,vt V Ri = IRit (1− V Ri)β1 (2.4) 2.4 Data sources and variables Combining information from several sources, the dataset is described in the following and summarized in Table 2.1 and Table 2.2. 2.4.1 Measuring compliance behavior and enforcement policy The major data source is the ECHO publicly provided by the U.S. EPA. This source provides the definition of formal enforcement action (FEA) with its data by facility within the last five years17: in practice, for firms with very high levels of pollution violation, civil or administrative enforcement action that is taken against them in the U.S. is called the formal enforcement ac- tion.18 ECHO also gives us information on the number of inspections by facility within the same time period (See Appendix A.3 for details). The number of formal enforcement actions and the number of inspections at the facility level were aggregated into the SIC 4-digit industry level respec- tively.19 Meanwhile, the numbers of total facilities inspected for each 4-digit industry were collected. 17ECHO has kept being updated. This paper uses the data last updated on Nov, 2008 at ECHO, so the inspection period starts from 2003. 18“In general, a violation at a facility means the facility has been noted as out of compliance with an environmental requirement set forth by the Clean Air Act, Clean Water Act, or Resource Conservation and Recovery Act statutes and their respective regulations...A violation may indicate that the facility released excessive pollutants, that a hazardous waste handling requirement was not met, or that a facility failed to submit a required report...Not all violations receive formal enforcement action. Violations that are minor, short in duration, or quickly corrected by the facility may not warrant formal enforcement action.”–cited from the EPA website. 19One thing to notice is that I do not use minor facilities which are not required to report because reported facilities may tend to be more environmentally compliant and could lead to bias. The other thing is that industries whose total number of inspected facilities is less than 5 are dropped because the sample is too small. 14 2.4. Data sources and variables I constructed the industry-level violation rate (VR) as the ratio of formal enforcement action numbers at the 4-digit industry level to the inspection numbers at the 4-digit level. It represents the probability of serious violation per inspection and is regarded as a measure of the noncompliance level for an industry. In this paper, I distinguish between serious and minor violations and use serious violations to capture the degree of violation. I use this because it is more likely that serious violations are chosen by facilities on purpose. That is, it is profit-maximizing for facilities to choose to be in non-compliance. On the contrary, minor violations are sometimes caused by accidents or other unexpected shocks. According to EPA, these minor violations are usually short in duration or quickly corrected by the facility, which avoids further formal enforcement actions.20 In order to measure the stringency of the enforcement policy, I divided the inspection number at the 4-digit level by the number of total facilities for each industry. The ratio is defined as the industry-level inspection rate (IR) describing the inspection probability that an industry is subject to. 2.4.2 Other variables Here I describe the other variables used. The data source of the chemical released amounts at the 4-digit level is the U.S. EPA’s Risk-Screening Envi- ronmental Indicators (RSEI) (Version 2.1.5),21 which use annually updated Toxic Release Inventory (TRI)22 data. I constructed emission intensity (EI) by dividing the chemical released amounts at the 4-digit industry level by the value of shipments. The data of the values of shipments are from the 1992 Census of Manufactures report MC92-S-2, “Concentration Ratios in 20Nevertheless, in so doing, one would under-estimate the effect of inspection on envi- ronmental outcome. This is because minor violations cost little for facilities to correct. Therefore, one can argue that minor violations are more sensitive or responsive to inspec- tions. We leave this for future research. 21See Appendix B.2 for details. 22“The Toxic Release Inventory (TRI) is a publicly-available EPA database that contains information on toxic chemical releases and other waste management activities reported annually by certain covered industry groups and federal facilities.” – User’s Manual for RSEI. 15 2.4. Data sources and variables Manufacturing”. This MC92 is also the data source for HHI (Herfindahl Hirschmann Index) that characterizes industry concentration.23 The proportion of firms that choose to shutdown is proxied by the vari- able ‘close’. This is the ratio of the number of Establishments Deaths24 in 1998 to that of Initial Year Establishments in 1997.25 The data are recorded in the U.S. government census and are only available at the 3-digit SIC level.26 The data of inputs were obtained from the 1996 Annual Sur- vey of Manufactures.27 The values of “production workers wages”, “cost of materials”, “new capital expenditures”, and “cost of purchased fuels and electric energy” are scaled by “value of industry shipments” to proxy the input shares w, k, Material and Energy respectively. The number of paid employees (EMP) is used to measure industry size and is from the 1997 Economic Census.28 Measures of Diverse Industry (DI) and Geographic Concentration (GC) were constructed following Grier, Munger and Roberts (1994). The number of segments is reported by each firm, up to a maximum of 10 in COMPUS- TAT industrial segment file. The data were averaged by industry (mean=1.7, s.d.=0.65) and a DI is defined as “one with mean number of products more than two s.d. above the sample average, that is, all industries whose firms average more than three products line are coded 1.0 and the others 0.00”. Because the data vary little at 4-digit level, I compiled them into 3-digit level data. And the data cover the period of 1998-2006. GC is calculated as ∑ i ( Salesi Sales )2 for each industry where i denotes state. The data of sales 23The 1997 data are available but are classified by NAICS (North American Industry Classification System) instead of SIC. 24Only enterprises whose sizes (the employment of the controlling enterprise in the initial year) are over 20 are included. 25Starting with the 2003-2004 tabulations, the industry classification is based on 2002 NAICS. Previous years data are based on 1997 NAICS (1999-2003) and SIC (1990-1998). 26Please see http://www.census.gov/csd/susb/susbdyn.htm. 27Please check http://www.census.gov/mcd/asm-as1.html. 28The Economic Census profiles American business every 5 years and the 2002 data are available. However, the 2002 Economic Census is based on NAICS. Given the violation rate is based on SICs, the conversion of employment based on NAICS into that based on SICs may lead to some bias. The 1997 data are available in both NAICS and SICs. And since the employment number is used to control for industry size that is relatively stable over short periods, I choose the 1997 data. 16 2.4. Data sources and variables (DATA12) in each state were collected from COMPUSTAT as well. Combining non-missing observations from these sources yields an un- balanced panel of 421 observations over the period 2003-2006, which is the sample used in this study. 17 2.4. D ata sou rces an d variab les Table 2.1: Variable Definition and Data Sources I Variable Description Sources Violation Rate (V R) =The number of formal enforcement actionsThe total number of inspections ECHO, 2003’-2008’ Close Rate (close) = The number of Establishments deathsThe number of initial year establishments U.S. gov’t census,the initial yr:97’,3-digit Inspection Rate (IR) =The total number of inspectionsThe total number of facilities ECHO, 2003’-2008’ Emission Intensity (EI) =The chemical released amountsThe value of shipments RSEI, 1992 Economic Census, 1996’-2005’ Industry Concentration (HHI) Herfindahl Hirschmann Index 1992 Economic Census, 1992’ Industry Diversity (DI) =1 for a large number of product lines =0 for a small number of product lines Industrial segment file in COMPUSTAT Grier et al.(1994), 1998’-2006’, 3-digit Industry Size (EMP ) The number of paid employment 1997 Economic Census, 1997’ Geographic Concentration (GC) = ∑ i ( Salesi Sales )2 (i: state) COMPUSTAT, Grier et al.(1994), 95’-06’ Labor Share (w) = Production workers wagesThe value of industry shipments 1996 ASM, 1996’ Capital Share (k) = New capital expendituresThe value of industry shipments 1996 ASM, 1996’ Material Share (Material) = Cost of materialsThe value of industry shipments 1996 ASM, 1996’ Energy Share (Energy) =Cost of purchased fuels and electric energyThe value of industry shipments 1996 ASM, 1996’ 18 2.4. D ata sou rces an d variab les Table 2.2: Summary Statistics I Variable Number of Mean Standard Minimum Maximum Indicator Observations Deviation V R 803 .12 .16 .013 1 Close 155 .05 .027 .01 0.16 IR 914 .39 .29 .03 1.69a lnEI 4115 12.68 2.57 -5.29 19.16 HHI 447 0.066 0.06 0.000056 0.297 DI 3950 .04 .20 0 1 lnEMP 419 9.95 1.11 6.20 13.18 GC 5302 .40 .24 .09 1 w 456 .11 .05 .01 .32 k 450 .03 .03 .001 .34 Material 455 .50 .13 .17 .90 Energy 455 .02 .03 .002 .21 a :IR could be larger than 1 because each facility could be inspected multiple times. 19 2.5. Empirical results 2.5 Empirical results The second-stage estimation results of equation (2.2a) are reported in Table 2.3.29 Column (1) of Table 2.3 contains the second-stage empirical results for the 2SLS estimation of the baseline specification with random effects. I use the predicted values of inspection rates (IR) and emission intensities (EI) to estimate specification (2.2a), controlling for the group heterogeneity and the changes in the election year by including Group2 and year2004. The included random effects account for the unobserved time-invariant industry heterogeneity. Inspection rate Our main interest is to find out how the inspection rate (IR) affects the violation rate. The estimated coefficient on the inspection rate is negative and significant at the 1 percent level.30 It corresponds to a mean marginal effect of -0.087 31 across 111 industries. The elasticities of the violation rate, evaluated at the mean values of the inspection rate and the mean values of the violation rate over time, vary from -0.089 to -1.03 as shown in Table 2.4. The mean value of the elasticity is about -0.34, implying that a 10 percent increase in the inspection rate yields a 3 percent reduction in the violation rate. The results suggest that a more stringent inspection policy improves the compliance, but the magnitudes vary greatly between inspection “elas- tic” industries (e.g., 2865 and 3313) and inspection “inelastic” industries (e.g., 3845 and 3661). Other variables 29The first stage results of estimating equation (2.2a) are reported in the appendix A.4. 30The subsample during period 2003-2005 is used because data of the emission intensity for 2006 are not available. 31The calculation is as follows based on the expression (2.3) in page 13: V R(1−V R)β = 0.107× (1− 0.107)× (−0.91) = −0.087. Here, the mean value of VR differs a bit from that in Table 2.2. This is because this mean value is across 111 industries whose elasticities can be calculated while the mean value in Table 2.2 is across the whole sample. 20 2.5. Empirical results Table 2.3: Second-Stage Results of Violation Rates Regressions (2003’- 2005’) Second-Stage Dependent Variable: lnVR-lnClose Independent IV Random IV Pooled IV fixed Random Pooled Fixed Variable (1) (2) (3) (4) (5) (6) IR −.91 ∗∗∗ (−3.52) −.93∗∗ (−2.26) −1.04∗∗∗ (−3.95) −.44∗∗ (−2.53) −.09 (−.53) −.92∗∗∗ (−4.16) lnEI .19 ∗∗∗ (3.27) .15∗∗∗ (2.82) .02 (.72) .002 (.11) .04 (.45) lnEMP −.1 ∗∗∗ (−1.68) −.1∗∗ (−2.20) −.14∗∗∗ (−2.66) −.12∗∗∗ (−3.20) HHI 1.9 (1.58) 1.48 (1.48) 1.1 (1.03) .42 (.51) DI .23 (.80) .23 (.74) .26 (.94) .32 (1.35) .37 (1.40) .25 (.95) GC .59 ∗∗ (2.29) .62∗∗∗ (2.97) .54 (.63) .62∗∗ (2.59) .64∗∗∗ (3.47) .48 (.57) Group2 0.34 ∗∗ (2.20) .28∗ (1.92) .05 (.45) −.01 (−.15) Year2004 .02 (.24) −.02 (−0.21) .02 (0.25) −.08 (−1.00) −.14 (−1.54) .006 (.08) R2 0.026 – 0.001 0.09 0.10 0.01 Obs. 319 319 319 323 323 323 Note: both IR and EI are endogenous and instrumented. *** Significant at the 1% level, ** at the 5% level, and * at the 10% level (t statistics are in parentheses) 21 2.5. Empirical results Table 2.4: Industries Ranked by the Estimated Elasticities of the Violation Rate (111 Industries) 5 Most Inspection “Elastic” Industries SIC Description Elasticity 2865 Cyclic Crudes and Intermediates -1.03 3313 Electrometallurgical Products -.88 2621 Paper Mills -.82 2812 Alkalies and Chlorine -.81 2631 Paperboard Mills -.79 5 Most Inspection “Inelastic” Industries SIC Description Elasticity 3271 Concrete Block and Brick -.10 2711 Newspapers -.10 3825 Instruments for Measuring and Testing of Electricity and Electrical Signals -.098 3845 Electromedical and Electrotherapeutic Apparatus -.094 3661 Telephone and Telegraph Apparatus -.089 22 2.5. Empirical results In Table 2.3, the estimated coefficient on the emission intensity is positive and significant at the 1% level, after both the endogeneity problems of the inspection rate and the emission intensity are addressed. Coefficient estimates on the other control variables are also reported in Column (1) of Table 2.3. Their signs and magnitudes fail to provide much information about their marginal effects since the dependent vari- able is lnV R − lnclose. However, their statistical significance does show that whether they are important in explaining the variation of the violation rates across industries. In particular, the estimated coefficient on GC32 is significantly different from zero at the p<0.05 confidence level. The group dummy, Group2, and the election year dummy, Year2004 are also controlled for. The group effect shows that the unobserved fixed differences between industries whose first digit SIC code is 2 and those whose first digit is 3 are captured. The election year effect is found to be insignificant. Column (2) of Table 2.3 presents the second stage results for the 2SLS estimation using the pooled data.33 Column (3) contains the second-stage results for the 2SLS estimation of the baseline specification with fixed effects. In columns (4), (5) and (6), they are the results from the random-effect, pooled OLS, and fixed-effect regressions respectively. But IR and EI are not instrumented. As I implement the fixed-effect estimation, some primary 32According to the Pollution Haven Hypothesis in existing literature, firms prefer lo- cation where environmental regulation/enforcement is weak. Firms, especially polluting firms whose abatement costs are large, agglomerate in places where enforcement is weak. GC can be regarded as a proxy of local strictness of environmental enforcement policy and has an influence on the violation rate. 33This estimate reports a negative R-squared using STATA. According to “Negative and missing R-squared for 2SLS/IV” by Scribney et. al. (1999), “for two-stage least squares, some of the regressors enter the model as instruments when the parameters are estimated. However, since our goal is to estimate the structural model, the actual values, not the instruments for the endogenous right-hand-side variables, are used to determine the MSS. The model’s residuals are computed over a set of regressors different from those used to fit the model. This means a constant-only model of the dependent variable is not nested within the two-stage least squares model, even though the two-stage model estimates an intercept, and the RSS is no longer constrained to be smaller than the TSS”. Thus, only standard errors matter for the estimates of these parameters produced by the two-stage model regardless of the value of R-squared. 23 2.6. Conclusions control variables are dropped. This is because the time series for these primary control variables are not available. The results are similar both in terms of magnitudes and significance levels across the first three alternate techniques of estimation in Table 2.3. 2.6 Conclusions This chapter assesses the impact of the inspection rate on the environmental pollution noncompliance level when the endogeneity problem of the enforce- ment policy is considered. The elasticity of an industry’s violation rate with respect to its inspection rate is estimated. I started with an econometric BLP model to build this work at the industry level while keeping the micro- foundations on firms’ optimal decisions. A linear relationship between the logarithsm of the industry-level violation rate and the inspection rate is derived, which is convenient for the application of the IV approach. In the empirical section, I estimated the structural empirical specifica- tion with the instruments for the inspection rate. The measures of the key variables at the industry level are firstly introduced and a new dataset is used. It complements the firm-level analysis in the literature. The 2SLS results indicate a significant deterrent effect of the inspection rate on the industry-level violation rate after the endogeneity of the inspection rate is considered. More importantly, I calculate the elasticities of the violation rate with respect to the inspection rate. And a substantial variation of the elasticity across industries is found. These estimates of elasticity would serve as a basis in the next two chapters for identifying the determinants of the environmental enforcement policy and the environmental political activity. 24 Chapter 3 The Formation of Environmental Enforcement Policy: Evidence from the U.S. Industry-level Data 3.1 Introduction The enforcement of environmental legislation is crucial for achieving a desir- able environmental outcome. How does the environment enforcement agency such as the environmental protection agency (EPA) enforce environmental regulatory policies? This paper intends to address this question in an envi- ronment where the environmental protection agency is explicitly constrained with a hard budget in monitoring polluting firms. Constrained by the hard budget, the enforcement agency has to target industries where inspections are more likely to be effective in achieving its goal, all else equal. This implies the important role of the elasticity of the violation rate with respect to the inspection rate in determining the inspec- tion stringency. For example, when the agency’s goal is to maximize the social welfare, if there exists no budget constraint, for the first-best case, inspection rates should be just set to ensure that the expected penalty (in- spection rate multiplied by the penalty) equals the marginal damages caused by the pollution violation.34 But the hard budget leads the inspection rates to deviate from the marginal damages. Then, similar to the Ramsey rule in 34At certain maximum penalty. 25 3.1. Introduction the optimal tax literature, the distortion is determined by the elasticities of the violation rate with respect to inspection rates to minimize the efficiency loss. Specifically, all else equal, a higher equilibrium inspection rate is set in an industry with a large absolute elasticity of the violation rate. This is because, if one industry is more elastic than the other industry, the dead- weight loss at the same inspection rate from inspecting the elastic industry is lower. This paper tries to empirically investigate whether the enforcement agency allocates the limited monitoring resources across industries based on the industry elasticity of the violation rate with respect to the inspection rate. EPA35 explicitly faces a hard budget constraint in monitoring firms36 to make sure they abide by environmental regulatory policies such as stan- dard and limit. Each year, the EPA develops a proposed budget defining the funding for the goal of compliance and related priorities. Then, the Congress37 passes bills to enact amended budgets into law.38 For example, the FY (fiscal year) 2010 Budget includes approximately $600 million for EPA’s Enforcement and Compliance Assurance program, and a $32 million increase over the FY 2009 Enacted level. In particular, for the Agency’s Compliance Monitoring program, in FY 2010, its proposed budget is $101.1 million39. As stated in the FY 2010, Compliance Monitoring activities will be both environmental media- and sector-based40. And the allocation of the budget involves multiple steps. In designing the allocation rule, the en- 35In the U.S., environmental enforcement takes place in the context of a system (the environmental federalism) consisting of local and state jurisdiction and the Federal en- forcement agency. Because this work focuses on the variation across industries instead of that across regions, I partly control for the role of the state and local communities with the geographical concentration variable and focus on the role of EPA. 36The monitoring process is to discover firms that are in violation of the law and to produce evidence. 37In particular, Jones and Scotchmer (1990) states that the enforcement budget is set by the Congressional appropriations committees. 38See details in the U.S. EPA website: http://www.epa.gov/ocfo/budget/. 39This Compliance Monitoring program reviews and evaluates the activities of the reg- ulated community to determine compliance with applicable laws, regulations, permit con- ditions and settlement agreements, and to determine whether conditions presenting im- minent and substantial endangerment exist. (FY2010 EPA Budget in Brief, U.S. EPA.) 40Source: FY2010 EPA Budget in Brief, U.S. EPA. 26 3.1. Introduction forcement agency sets some priorities at the industry level first41. Then, given the resources allocated to certain industry, more specific amount of resources directed to each firm within this industry would be decided42. In this work, I study the allocation rule at the industry level only. The elasticity of an industry’s violation rate with respect to the inspec- tion rate reflects the power of monitoring to alter an industry’s violation status. I regard this elasticity as an important characteristic of an industry and estimated the elasticities in Chapter two. As shown by Gray and Shad- begian (2005) that pulp mills are less sensitive to inspections than paper mills, the estimation results of Chapter Two also show the great variation across industries in the elasticity. The role of the elasticity of the violation rate with respect to the in- spection rate in determining the enforcement policy stringency has not been explored in the literature. Existing works empirically paid attention to two groups of factors43(e.g., Laplante and Rilstone, 1996; Lear, 1998; Helland, 1998; Deily and Gray, 1991, 1996; Dion, Lanoie and Laplante, 1998) in ex- plaining the pattern of inspections. One is the past violation history, which could lead to a higher probability of being inspected in subsequent peri- ods. This is consistent with the dynamic targeting approach described by Harrington (1988) and others44 which ensures compliance at reduced moni- toring costs. For the other group, the role of the factors in determining the 41Or, when the priorities are set based on the environmental media, some industries that release these regulated pollutants intensively are subject to more stringent policy than others. That is, priorities on some industries are implicitly defined in this case. 42“The priority system adopted by the Michigan Occupational Safety and Health Act (MIOSHA) for conducting scheduled, programmed inspections in private sector workplaces involves two major steps. In the first step, MIOSHA designated target industries. In the second step, MIOSHA generates a priority list of establishments to be inspected based on the targeted industries.” Source: “General Industry Inspection Priority System Pro- grammed Scheduled Inspections” by General Industry Safety & Health Division, MOSHA, March 2010 43For details, see Cohen (1999). 44Cohen (1999) states that this prior history of violation environmental laws can also be explained by the economic theory of regulation (if the public demands it) or compliance maximization (since the agency is most likely to find violations at these firms) besides the social cost minimization (based on the dynamic models) empirically. I emphasize the explanation under social cost minimization in this work. 27 3.1. Introduction enforcement policy are explained from the political perspective. The factors include the per-capita level of pollution, the affluence of the community, the affected labor force’s percentage of the local population, the compliance cost45, the firm size46 and others. Thus, this study provides an additional explanation -the elasticity of the violation rate- for the observed differences in the stringency of enforcement policy.4748 I exploit the variation in the inspection rate and the elasticities of the violation rate (constructed in Chapter Two) from the United States manu- facturing industries to test the theoretical predictions. The inspection rate at the industry level is the percentage of inspection number in the number of inspected facility for each industry. That is, it is the inspection number that an inspected facility is subject to. This is used to proxy the enforcement policy stringency. Moreover, I control for an important industry characteristic – the pol- lution damage indicator. The damage indicator is defined as a measure of industry-specific pollutants’ potential damage to the environment and hu- man health per unit of emission in this work. That is, it describes the toxicity of the chemical and the number of people affected. Pollutants with potential damage have been known to vary across industries for a while (Hettige, Mani and Wheeler, 2000; Olewiler and Dawson, 1998). For in- stance, Olewiler and Dawson (1998) argue: “they can highlight industries that produce compounds that are more toxic-intensive than others, even though some of these industries may not have very large emissions intensity 45In Gray and Deily (1996), plants with a high cost of compliance are more likely to spend money fighting against a stricter enforcement action. 46Lear (1998) finds a “deeper pockets” effect with higher fines for larger firms. 47Although different theories (along with predictions about factors that affect the en- forcement policy) arises based on various assumptions about the enforcement agency’s goal (such as the net political support maximization, the bureaucratic benefit maximiza- tion or the compliance maximization), the factors are not exclusive to each other in the empirical test. 48Theoretical works in this line about the priorities for enforcement are based on how firms differ. For example, firms’ prior compliance history or expected compliance behavior (Harrington 1988, Russell 1990 and harford 1991); firms’ opportunities to evade and pri- vate benefits from polluting (Macho-Stadler and Perez-Castrillo 2006); firms’ compliance costs (Jones and Scotchmer 1990). 28 3.1. Introduction ratios.” It was not rigorously incorporated in a theoretical model and em- pirically tested until recently (see Michida and Nishikimi, 200749; Antweiler, 2003). Because one unit of violation by an industry with a large damage indicator leads to a high social cost, I predict that a larger inspection rate is set in this industry, all else equal. Data collection of the damage indicator is adopted from the EPA’s Risk-Screening Environmental Indicators (RSEI) Version 2.1.5.50 I find that both of (the reciprocal of) the elasticity of the violation rate and the damage indicator have significant effects on the inspection rate level in both of the IV and the OLS estimations. In particular, a strong complementary effect between the damage indicator and the elasticity of the violation rate on the inspection rate is found. The net effect of the absolute elasticity is shown to be positive and significant. This supports the prediction that the elasticity of the violation rate determines the inspection rate in a modified Ramsey pricing rule in the presence of a hard budget constraint. The net effect of the damage indicator is conditional on the elasticity of the violation rate. The intuition is as follows: although the violation of an industry with a larger damage indicator may lead to a larger social cost, each inspection of this damaging industry’s behavior may be more costly. When the elasticity of the violation rate is small, that is the inspection is not effective, an enforcement agency may choose to inspect this industry less. In contrast, when the elasticity of the violation rate is large enough, an industry with a larger damage indicator is subject to a larger inspection rate. The rest of the chapter is organized as follows. In Section 3.2, I develop a simple theoretical model to show how the damage indicator and the elas- ticity of the violation rate determine the environment enforcement policy in equilibrium. Section 3.3 presents the empirical specification and describes the data. In Section 3.4, I present the empirical results. Section 3.5 con- 49Industry-specific pollutants are modeled by Michida and Nishikimi (2007)[54]: “in terms of industrial pollution, there exist a large variety of toxic substances, some of which are not common across different industries.” 50see Appendix B.2 for details. 29 3.2. A simple theoretical model - enforcement with heterogeneous industries ducts the robustness checks. Conclusion is provided in Section 3.6. Proofs of propositions and some supplementary data descriptions are contained in Appendix B. 3.2 A simple theoretical model - enforcement with heterogeneous industries Suppose firms in an industry are identical and polluting. A representative firm could be in compliance or in violation51. The firm can control its viola- tion probability by changing the environmental expenditure, e.g., the level of investment in pollution abatement equipment, the number of employees in the pollution management, and the employment of cleaner input in pro- duction. It decides its violation probability v ∈ (0, 1] to maximize its profit. The violation probability decreases as the firm devotes more environmental expenditure, but the environmental expenditure has to be infinitely large to keep the violation probability at zero. The net benefit from violation –B (v, k)– is increasing in violation prob- ability, v. The functional form of B (v, k) is assumed to be vθk1−θ 52. The benefit may come from saved abatement cost and related gains from more pollution (e.g. a lower output price as the cost becomes lower). This net benefit also depends on a sector-specific input k. The sector-specific input is limited and inelastically supplied, and the technology shows constant return in both factors but diminishing return in individual factors. This production 51The extent of the violation is neglected to focus on the violation rate (as a result of dichotomous compliance/non-compliance determination) in this work. As Oljaca et al. (1998) indicate that the violation size has also been neglected in Viscusi and Zeckhauser (1979), Jones and Scotchmer (1990), Harrington (1988), Harford and Harrington (1991), Jost (1997), Malik (1993). In this line of literature, it is assumed that the agency chooses the maximum fine level within certain externally-imposed limit (e.g. the wealth of the offender, the social norms of fairness) to achieve the greatest deterrence. In practice, the U.S. EPA calculates its civil penalty with a ‘gravity’ component which is based on the harm from the offense. This component of the EPA penalty is based on qualitative descriptions of harm and is not directly related to any quantitative measure of harm (Cohen, 1999). 52This power function form is necessary to derive a constant elasticity of the violation rate with respect to the inspection rate in the following. 30 3.2. A simple theoretical model - enforcement with heterogeneous industries structure leads to a quasi-rent pi for the fixed factor. At the industry level, v is regarded as the industry-level violation rate because firms are identical in an industry. An agency that enforces a pollution standard monitors and imposes a sanction once a violation is detected. A sanction could be a fine or some other costly penalty and its level is assumed to be exogenous 53. The en- forcement agency decides the inspection rate p ∈ [0, 1] to maximize the social welfare. This is a Stackleberg game: the enforcement agency announces the inspection rate and the firms decide their violation probabilities afterwards. Therefore, a firm’s choice of violation probability is influenced by the in- spection rate announced by the enforcement agency. The optimization problem of a representative firm can be written as Max v pi = B (v, k)− ptv (3.1) where v is the violation probability, and B (v, k) is the benefit from violating the pollution standard. The detected violation rate is pv. The total fine is ptv which depends on both the detected violation rate and the penalty t54. The first order condition is: Bv (v, k)− pt = 0 (3.2) This shows that the marginal benefit of increasing the violation prob- ability is equal to its marginal penalty. A firm’s violation probability is decreasing in the inspection rate. The enforcement agency has to incur costs in monitoring firms so as to discover and verify a violation. And the agency’s inspection expenditure is increasing with a larger violation probability for each firm. I assume that the inspection expenditure on a representative firm in industry i is epivi, 53In Garvie and Keeler (1994), it is pointed out that the size of financial penalties is dependent on institutional factors (e.g. judicial attitudes, higher level support from the executive branch, and public opinion) largely outside the control of both firms and regulators. 54A relatively more general functional form, a power function of v, is also easy to be used to derive the same propositions and predictions. 31 3.2. A simple theoretical model - enforcement with heterogeneous industries where e is the monitoring expenditure coefficient and it is the same across industries. 55 The total inspection budget is assigned by the Congress and is limited. The enforcement agency chooses an industry-specific inspection strategy to maximize the social welfare subject to the budget constraint and firms’ reaction functions in equation (3.2), Max pi Ω = ∑ i pitvi − ∑ i ρivi + ∑ i pii s.t. ∑ i epivi ≤ E Bv (v, k)− pt = 0 (3.3) where ρj is the pollution damage indicator in industry i so that ρivi repre- sents the pollution disutility from this industrial pollution violation. Here, the pollution damage indicator is an important characteristic of industry- specific pollutant. It represents different levels of risks to the environment and human health, including information such as the toxicity or the prox- imity to consumers. This corresponds to the sector-specific input. pitvi is the penalty collected from industry i and is redistributed lump-sum to all individuals. Thus, the social welfare is defined as the sum of the pollution disutility, the expected collected penalty and the total profits across all in- dustries. In the budget constraint, epivi is the inspection cost function. E is the total budget assigned by the congress. I define εi = ∂vi ∂pi pi vi = 1 θ − 1 56 as the elasticity of the violation rate with respect to the inspection rate. In equilibrium, the industry i’s inspection 55The inspection expenditure depends on both the inspection probability and the vi- olation probability in this thesis. It can be expected that the inspection cost is higher for a serious and large amount violation because the workload is high. But the extent of the violation has been neglected to focus on the violation rate as a result of dichotomous compliance/noncompliance decision (The explanation is in footnote 47 in page 29.). I use the violation probability to proxy the expected violation size assuming that the mean vi- olation amount is the same across industries. That is, if an industry has a larger violation probability, its expected violation size is larger. Each inspection may incur a higher cost and the total inspection expenditure is larger. In addition, there may exist additional enforcement actions required for firms that are found violating, such as control orders, phone calls, meetings etc., so the total inspection costs are higher when more firms are found in violation. 56This is derived from Equation (3.2) when B (v, k)=vθk1−θ 32 3.3. Empirical specification and data frequency the agency chooses satisfies: pi = 1 t− λe ( 1 + 1εi )ρi (3.4) Proof. See Appendix B.1 where the Lagrangian multiplier λ is positive because an increase in the budge E implies a gain in social welfare. It reflects the opportunity cost of a dollar in terms of gaining the social welfare. This gives the following relationships for the inspection rate: Proposition 1 In equilibrium, all else equal, the enforcement agency in- spects the following industries more frequently: (i) the industries with larger absolute values of the elasticity of the vio- lation rate with respect to the inspection rate |ε|; (ii) the industries whose damage indictor ρ is larger. If one industry is more elastic than the other industry, the deadweight loss at the same inspection rate from inspecting the elastic industry is lower. Then the enforcement agency may devote more resources to inspecting the industry whose absolute elasticity of violation rate is large. And a high equilibrium inspection rate is set in this industry. Equation (3.4) provides a suitable platform for empirical analysis and identification with data from the USA. 3.3 Empirical specification and data 3.3.1 The inspection rate equation Equation (3.4) suggests the central roles of two variables (the damage in- dictor ρ and the reciprocal of the elasticity of the violation rate 1ε ) in de- termining the inspection rate that represents the enforcement policy level. I estimate three specifications below from a simplified linear approximation 33 3.3. Empirical specification and data to a general nonlinear functional form.57 Specification one I incorporate 1 ε and ln ρ as regressors in Specification One in a linear way as follows, ln IRi = β0 + β1 ( 1 ε ) i + β2 ln ρi + β3 lnEIi + β4 lnEMPi + β5HHIi + β6DIi + β7GCi + β8Groupi + i (3.5a) where IR is the industry-level inspection rate, ρ is the pollution damage indicator, 1ε is the reciprocal of the elasticity of the violation rate, Group is a group dummy (the first digit of SIC code is 2 or 3),  is a zero-mean error term, i is the industry index. The general industry conditions to be controlled for include the following: EI: the level of emission intensity. HHI: the Herfindahl-Hirschman Index measuring the concentration of firms in an industry (the industry concentration). DI: “diverse industry” is a measure describing the number of different segments in which a firm operates. EMP : the number of paid employment as a measure of industry size. 57The elasticity of the violation rate is regarded to be exogenous in the estimations. On the one hand, it is regarded as an industry characteristics. As shown by the theoret- ical work, εi = ∂vi ∂pi pi vi = 1 θ − 1 in a simplified framework. At the micro-level(the facility level), the elasticity of violation may be endogenous, while we aggregate the data to the industry level, which lessens the degree of endogeneity of the violation elasticity. More- over, in the empirical papers that test the predictions of Grossman and Helpman (1994), elasticity (although different from that in my paper) is treated as exogenous (as an indus- try characteristic) to explain the differences in tariff across industries (see Gawande and Bandyopadhyay, 2000). Nevertheless, the estimated coefficients on the elasticity of viola- tion may be biased to some extent. However, since the estimated coefficients are generally significant at the 1% level, the potential bias might not affect the main predictions much. 34 3.3. Empirical specification and data GC: “geographic concentration” describes the dispersion of firms according to their locations. Specification two I amend Specification One by adding an interaction term between ln ρ and 1 e as Specification Two. This is to catch the possibility that the effect of the elasticity of violation may be conditional on an industry’s damaging level (represented by the value of the damage indicator ρ). I therefore use the following as Specification Two, ln IRi = β′0 + β ′ 1 ( 1 ε ) i + β′2 ln ρi + β ′ 1,2 ( ln ρi × 1 ε i ) + β′3 lnEIi + β ′ 4 lnEMPi +β′5HHIi + β ′ 6DIi + β ′ 7GCi + β ′ 8Groupi + i (3.5b) Specification three I consider a general nonlinear functional form by adding higher order terms for ln ρ, 1 e and their interaction term as follows, ln IRi = β′′0 + β ′′ 1 ln ρi + β ′′ 11 (ln ρi) 2 + β′′2 ( 1 ε ) i + β′′22 ( 1 ε i )2 + β′′1,2 ( ln ρi × 1 ε i ) + β′′11,22 ( ln ρi × 1 ε i )2 + β′′3 lnEIi + β′′4 lnEMPi + β ′′ 5HHIi + β ′′ 6DIi + β ′′ 7GCi +β′′8Groupi + i (3.5c) 3.3.2 Endogeneity of the emission intensity When estimating the three specifications above, I adopt the IV approach to overcome the potential endogeneity problem of the emission intensity. This endogeneity problem arises because the inspection rate has an influence on 35 3.3. Empirical specification and data the emission intensity as shown below in a reduced-form specification58. lnEIi = γ0 + γ1IRi + γ2 lnwi + γ3 ln ki + γ4 lnMateriali (3.6) +γ5 lnEnergyi + γ6 (controls) + ϕit where EI is the emission intensity, w is the labor share, k is the capital share, Material is the material share, Energy is the energy share, (controls) include industry characteristics, and Groupi is the group dummy. In estimating equations (3.5a), (3.5b) and (3.5c), lnEI is instrumented with the input shares (lnw, ln k, lnmaterial, ln energy). 3.3.3 Data description This section describes the data sources and how they are utilized to con- struct measures of the interested variables. Table 3.1 provides definitions and sources of the variables, and Table 3.2 summarizes the descriptive statis- tics of the variables used in the empirical analysis.59 Regulatory variable The dependent variable that measures the environmental enforcement policy is the inspection rate (IR). The data source of IR is the “Enforcement & Compliance History Online (ECHO)” publicly provided by the U.S. EPA. This source provides information on the number and dates of inspections by facility within last five years60 (See Appendix A.3 for details). The number of inspections at the facility level was aggregated into the SIC 4-digit industry 58This is similar to the Equation (2.2c) in Chapter Two. But in estimation of Equation (2.2c), I use a panel data and time varies from 2003’ to 2005’. In estimating Equation (3.6), I conduct a cross-industry analysis only. 59Some variables are used for estimation both in this chapter and Chapter Two. Thus, the description of the measurement and data sources for these variables are the same as those in Chapter Two. 60ECHO has been keeping updated. This paper uses the data last updated on Nov, 2008 at ECHO. So the inspection period starts from 2003. 36 3.3. Empirical specification and data level respectively.61 Meanwhile, the total number of facilities for each 4-digit industry was collected. I divided the inspection number at the 4-digit level by the number of facilities for each industry. The ratio is defined as the industry-level inspection rate IR describing the inspection number that an industry is subject to. I also use the abatement cost per unit emission (AC emission) as a proxy of the enforcement policy in the robustness checks in Section 3.5. The data source of AC is the file of “Pollution abatement costs and expenditures: 1994” from U.S. Bureau of the Census. AC emission is defined as the ratio of the sum of operating costs for all media (PAOC) and capital expenditure for pollution abatement (PACE) to the “TRI pounds”.62 “TRI pounds” refer to the pounds released or transferred by industries, and are reported in the U.S. EPA’s Risk-Screening Environmental Indicators (RSEI Version 2.1.5). Damage indicator and elasticity of the violation rate The damage indicator ρ and the elasticity of the violation rate ε are two important independent variables. Data source of the damage indica- tor is also the U.S. EPA’s Risk-Screening Environmental Indicators (RSEI Version 2.1.5)63. RSEI contains “risk-related results”, which imposes a risk score on industries at different SIC levels. The toxicity, surrogate dose, and population components are multiplied to calculate this risk score. It is used to assess the potential impact of industrial releases. The data are available for 1996’-2005’. The risk score (“risk-related results”) is defined as the dam- age indicator in this chapter. This dataset has been seldom explored to my knowledge. The damage indicator is similar to the measure of environmental 61I do not use minor facilities which are not required to report because reported facilities may tend to be more environmentally compliant and could lead to bias. And industries whose total number of inspected facilities is less than 5 are dropped because the sample is too small. 62The data in some industries are withheld to avoid disclosure, and no industries are shown where PAOC or PACE is less than $1.0 million. 63See Appendix B.2 for details. Data of the damage multiplier is available with the SIC code instead of NAICs. 37 3.3. Empirical specification and data exposure in Antweiler (2003) to some extent64. Elasticity of the violation rate with respect to the inspection rate is the measure of responsiveness in the industry-level pollution violation rate as a result of change in the enforcement policy. It was calculated in Chapter Two. Other variables I describe the other variables used in the analysis as follows. The number of paid employees (EMP) is used to measure industry size and is from the 1997 Economic Census.65 The 1992 Census of Manufactures report MC92- S-2, “Concentration Ratios in Manufacturing”, is the data source for HHI (Herfindahl Hirschmann Index) that characterizes the industry concentra- tion66. I constructed the emission intensity (EI) by dividing the chemical released amounts at the 4-digit industry level in 1996’67 by the value of ship- ments. The data source of the chemical released amounts at the 4-digit level is the U.S. EPA’s Risk-Screening Environmental Indicators (RSEI) (Version 2.1.5)68 that uses annually updated Toxic Release Inventory69 data. The 64It combines a firm’s composition and toxicity of emissions and its location that deter- mines the size of the population at risk with the firm’s size and intensity of pollution. This measure of environmental exposure is utilized as one of firm characteristics to investigate its effect on firm’s abatement effort. This effect is used to back out the effect of green reg- ulatory threat which is not directly measurable. Because environmental exposure triggers regulation, it has been shown that the effectiveness of threat depends on environmental exposure of a firm. It also depends on abatement ladder rung of a firm and government’s incentive scheme as argued in this paper. 65The Economic Census profiles American business every 5 years and the 2002 data are available. However, the 2002 Economic Census is based on North American Industry Classification System (NAICS). Given the violation rate is based on SICs, the conversion of employment based on NAICS into that based on SICs may lead to some bias. The 1997 data are available in both NAICS and SICs. And since the employment number is used to control for industry size which is relatively stable over short periods, I choose the 1997 data. 66The 1997 data are available but are classified by NAICS instead of SIC. 67I use the data in 1996’ because the data of inputs are in 1996’. 68See Appendix B.2 for details. 69“The toxic Release Inventory (TRI) is a publicly-available EPA database That con- tains information on toxic chemical releases and other waste management activities re- ported annually by certain covered industry groups and federal facilities.” – User’s Manual for RSEI 38 3.3. Empirical specification and data data of the values of shipments are from the 1992 Census of Manufactures report MC92-S-2, “Concentration Ratios in Manufacturing”. The data of inputs were obtained from the 1996 Annual Survey of Manufactures.70 The values of “production workers wages”, “cost of materials”, “new capital ex- penditures”, and “cost of purchased fuels and electric energy” are scaled by “value of industry shipments” to proxy the input shares w, k, Material and Energy respectively. The value of industry shipments is from the 1996’ ASM. Measures of Diverse industry (DI) and Geographic Concentration (GC) were constructed following Grier, Munger and Roberts (1994). The number of segments is reported by each firm, up to a maximum of 10 in COMPUS- TAT industrial segment file. The data were averaged by industry (mean=1.7, s.d.=0.65) and a diverse industry is defined as “one with mean number of products more than two s.d. above the sample average, that is, all industries whose firms average more than three products line are coded 1.0 and the others 0.00”. Because the data vary little at 4-digit level, I compiled them into 3-digit level data. And the data cover the period of 1998-2006. Geo- graphic concentration is calculated as ∑ i ( Salesi Sales )2 for each industry where i denotes state. The data of sales (DATA12) for each state were collected from COMPUSTAT as well. Combining non-missing observations from these sources yields an unbal- anced panel of 331 observations over the period 2003’-2005’. I take the mean values over the three years as the sample used in this chapter in estimation. 70http://www.census.gov/mcd/asm-as1.html. 39 3.3. E m p irical sp ecifi cation an d d ata Table 3.1: Variable Definition and Data Sources II Variable Description Sources Inspection Rate (IR) =The total number of inspections The total number of facilities ECHO, 2003’-2008’ Industry Concentration (HHI) Herfindahl Hirschmann Index 1992 Economic Census, 1992’ Industry Diversity (DI) =1 for a large number of product lines=0 for a small number of product lines Industrial segment file in COMPUSTAT, 3-digit Grier et al.(1994), 98’-06’ Industry Size (EMP ) The number of paid employment 1997 Economic Census, 97’ Geographic Concentration (GC) = ∑ i ( Salesi Sales )2 (i: state) COMPUSTAT,95’-06’Grier et al.(1994) Damage Indicator (ρ) Risk-related results RSEI, 1996’-2005’ Elasticity of Violation Rate (ε) A measure of responsiveness in the violation rate as a result of change in inspection rate Chapter Two, no time series Variables that appear in the robustness checks only Abatement Cost (ln AC Emission ) =Abatement operating costs+Capital expenditure TRI pounds “PACE1994” and 1996 ASM, 1994’ 40 3.3. E m p irical sp ecifi cation an d d ata Table 3.2: Summary Statistics II Variable Number of Mean Standard Minimum Maximum Indicator Observations Deviation IR 914 .39 .29 .03 1.69a lnEI 4115 12.68 2.57 -5.29 19.16 HHI 447 0.066 0.06 0.000056 0.297 DI 3950 .04 .20 0 1 lnEMP 419 9.95 1.11 6.20 13.18 GC 5302 .40 .24 .09 1 ln ρ 4134 7.91 3.50 -10 16 1/ε 111 -.4.0 2.19 -11.3 -0.9 Variable that appears in the robustness checks only ln ACEmission 109 -11.76 2.11 -16.18 -2.64 a: IR could be larger than 1 because each facility could be inspected multiple times. 41 3.4. Empirical results 3.4 Empirical results The results are reported in Table 3.3. Columns (1)-(3) correspond to the three specifications 3.5a-3.5c with the OLS estimation. In Column (4), lnEI is instrumented with the input shares (lnw, ln k, lnmaterial, ln energy). This is a cross-industry analysis. In all regressions, the observed industry het- erogeneity (lnEMP , HHI, GC, DI), and the group effect are controlled for. In column (1), the result shows that the estimated coefficient on the inverse elasticity 1/ε is positive and significant at the 1% level. This positive sign is consistent with the prediction implied by equation (3.4). That is, the enforcement policy is more stringent (a higher level of inspection rate) for industries with large absolute elasticities. The natural log of the pollution damage indicator ln ρ has a positive effect on the inspection rate, but the coefficient is not statistically significant. lnEI has a positive and significant estimated coefficient. Column (2) reports the results when the interaction between ln ρ and 1/ε is included. It shows that the estimated coefficients on ln ρ is still positive and becomes significant. The interaction term ln ρ× 1/ε has a positive and statistically significant estimated coefficient at the 1% level. The strong sig- nificance level of the estimated coefficient on the interaction term suggests the existence of a complementary effect between ln ρ and 1/ε. I conducted two other tests for additional evidences about the existence of this interac- tion term. First, because Specification one is nested in Specification two, I test the restrictions imposed in Specification one via a likelihood ratio (LR) test. The LR test statistic is presented at the bottom of Column (1) and is very significant. The restrictions are rejected and the result is in favor of Specification two. Second, in Column (2), I report the result of the joint significance test of ln ρ and the interaction term and the result of the joint significance test of 1/ε and the interaction term. The null hypothesis that the coefficients of both ln ρ and the interaction term are zero is strongly rejected. The result of the joint significance test for 1/ε and the interaction term is similar. 42 3.4. Empirical results I explore their effects in determining the inspection level further by cal- culating the net effect. The net effect of the reciprocal of the elasticity of violation 1/ε on the inspection rate, ln IR, is positive for around 98.8 per- cent of industries. In particular, at the sample mean of ln ρ71, one standard deviation increase in 1/ε would approximately increase the inspection rate level ln IR by 0.49.72 The net effect of the damage indicator is conditional on the elasticity. At a larger absolute elasticity of violation rate, the net effect of the damage indicator is positive. But when the absolute elasticity is small enough, the net effect becomes negative. This is because each in- spection of an industry with a larger damage indicator has to incur more inspection cost. When the inspection is not effective at deterring violation for this industry, the enforcement agency chooses to inspect less.73 In Column (3), I estimate Specification three which is a more general non- linear function by adding (ln ρ)2, ( 1 ε )2, and (ln ρ× 1ε)2 to Specification Two. The estimated coefficients on ln ρ, 1/ε and the interaction term ln ρ × 1/ε are positive. The estimated coefficient on 1/ε is still significant. This is sim- ilar to the results of Specification two in Column (2). The estimation finds significantly effects of the quadratic term of 1/ε and that of the interaction term ( ln ρ× 1ε ) . This serves as further evidence that the interaction terms are necessary to be considered. As shown at the bottom of Column (2), the result of the LR test that tests the restrictions on Specification Two is very significant. Moreover, R2 increases from 0.88 to 0.95. Thus, considering the role of higher orders for the interaction term may improve the performance of the regression. However, there exists concern that the specification with 71The summary statistics of ln ρ in this sample: mean=7.91, s.d.=3.50, min=-10, max=16. 72The calculation is as follows: [0.04 + (0.023)× 7.91]× 2.2 = 0.49, where the standard deviation of 1/ε is 2.2. 73This result can be obtained by slightly modifying the theoretical model. In the enforce- ment agency’s maximization problem (6), I assume the monitoring expenditure coefficient e is an increasing function of the damage indicator ρ. Then Equation (7) can be rewritten as pi = 1 t− λe (ρi) ( 1 + 1 εi )ρi = 1 t+ λe (ρi) ( 1 |εi| − 1 )ρi. It shows clearly that the effect of the damage indicator is conditional on the absolute elasticity. When the absolute elas- ticity is small enough, an increase in the damage indicator may lower the inspection rate due to a higher inspection expenditure. 43 3.5. Robustness and sensitivity analysis higher orders for the interaction term may be subject to the multicollinear- ity problem to some extent. And the estimated coefficients in Specification (3) are not directly interpretable. Thus, of the three specifications in the first three columns, I put more emphasis on Specification (2). Based on Specification Two (Equation 3.5b), I control for the endogene- ity of lnEI using the IV method and report the results in Column (4). The estimated coefficients in Column (4) are similar to those in Column (2) both in terms of the magnitude and the significance level. The only big difference is that the estimated coefficient on lnEI becomes bigger after its endogene- ity is controlled for. In sum, it confirms the hypothesis that the inspection rate structure across industries depends on the inverse elasticity of the vio- lation rate. Moreover, there exists a strong complementary effect between ln ρ and 1/ε in determining the inspection rate. 3.5 Robustness and sensitivity analysis To investigate the robustness of the findings, I run another group of regres- sions, with the results reported in Table 3.4. Table 3.4 contains estimates based on the second measure of the enforcement policy, the abatement cost per unit emission. The abatement cost per unit emission replaces the inspec- tion rate and the logarithm of the abatement cost (ln ACEmission) is employed as the dependent variable. Columns (1)-(4) correspond to the four columns in Table 9 respectively. The abatement cost data are one year (1994’) cross- industry data. The mean values over time are used for time varying inde- pendent variables (ln ρ, DI, GC) and the number of observations reduces to 108. Results in Columns (2)-(3) show the existence of the interaction term’s effect on the enforcement policy level. The estimated coefficient on the in- verse elasticity 1/ε is negative. This is perhaps because ln ACEmission captures not only the stringency of the enforcement policy, but also that of the en- vironmental regulation (e.g. the emission limit). lnEI has a negative and significant estimated coefficient in contrast to the positive estimated coeffi- cient in Table 3.3. 44 3.5. Robustness and sensitivity analysis Table 3.3: Inspection Rates Regressions Dependent variable: ln IR Independent OLS OLS OLS IV Variable (1) (2) (3) (4) lnρ .013 (1.07) .10∗∗∗ (6.8) .12∗∗ (2.09) .10∗∗∗ (5.38) 1/ε .19∗∗∗ (11.50) .04∗ (1.86) .35∗∗∗ (3.45) .04∗ (1.84) lnρ× (1/ε) .023 ∗∗∗ (7.73) .04∗∗∗ (2.78) .023∗∗∗ (7.56) (ln ρ)2 −.004 (−1.65) (1/ε)2 .02∗∗∗ (3.94) (ln ρ× 1/ε)2 .0003 ∗∗∗ (3.31) lnEI .02 (1.08) .01 (0.62) −0.002 (−0.28) 0.007 (0.25) lnEMP −.04 (−1.56) −.02 (−1.22) .008 (0.63) −.02 (−1.16) HHI .54 (1.10) .15 (0.38) .08 (0.32) .15 (0.37) DI .22 (0.90) −0.06 (−0.31) −.09 (−0.75) −.06 (−0.30) GC −.03 (−0.29) 0.05 (0.54) .06 (1.04) .05 (0.51) Group2 .11∗ (1.93) .10∗∗ (2.06) .07∗∗ (2.35) .09∗ (1.76) R2 0.81 0.88 0.95 0.88 Obs. 110 110 110 110 F-statistic for the joint significance test (Prob>F) lnρ, lnρ× (1/ε) 30.74∗∗∗ 1/ε, lnρ× (1/ε) 134.37∗∗∗ lnρ, lnρ× (1/ε) , (ln ρ)2 , (ln ρ× 1/ε)2 4.41∗∗∗ 1/ε, lnρ× (1/ε) , (1/ε)2 , (ln ρ× 1/ε)2 199.82∗∗∗ LR test /χ2 51.48∗∗∗ 102.39∗∗∗ *** Significant at the 1% level, ** at the 5% level, and * at the 10% level (t statistics in parentheses) 45 3.6. Conclusions In addition, for the four columns in Table 3.3, I run regressions for each year from 2003’-2005’ instead of using the mean value over the three years. The results are similar and not reported here. 3.6 Conclusions This chapter investigates the determinants of the environmental enforcement policy when the enforcement agency is constrained by a hard monitoring budget. I started with a simple theoretical model to emphasize two indus- try characteristics: the damage indicator and the elasticity of the violation rate with respect to the inspection rate. The damage indicator measures the industry-specific pollutants’ potential damage to the environment and hu- man health. Industries with large damage indicators may be subject to more inspections because of the high social costs resulting from their violation, all else being equal. The elasticity of violation reflects the responsiveness in the industry-level pollution violation rate as a result of change in the enforcement policy. Deadweight loss from inspection is smaller in industries with large absolute elasticities of the violation rate so that the enforcement agency tends to direct more resources to these industries and inspect them more frequently, all else being equal. In the empirical section, I estimated the linearized specification and its more general forms. The results identified the effects of the damage indicator and (the reciprocal of) the elasticity of the violation rate on the inspection rate level. In particular, a strong complementary effect between the damage indicator and the elasticity of the violation rate on the inspection rate is found. Existing works have not empirically linked these two industry character- istics to the enforcement level. The dataset about the damage indicator has been seldom explored, and the data of the elasticities that are calculated in Chapter Two are unique. This chapter calls for more attention on the indicators that measure the overall damage to the environment and human health in addition to the traditional pollution measurement – the emission intensity. 46 3.6. Conclusions Table 3.4: Robustness of Inspection Rates Regressions Dependent variable: ln ACEmission a Independent OLS OLS OLS IV Variable (1) (2) (3) (4) lnρ .001 (.02) .17∗ (1.78) .73 (1.35) .15 (1.16) 1/ε .23∗∗∗ (2.87) −.03 (−.24) −.75 (−.80) −.04 (−.26) lnρ× (1/ε) .04 ∗∗ (2.32) .20∗ (1.71) .04∗∗ (2.20) (ln ρ)2 −.02 (−1.06) (1/ε)2 −.03 (−.64) (ln ρ× 1/ε)2 .001 ∗ (1.67) lnEI −.85∗∗∗ (−11.11) −.87∗∗∗ (−11.53) −.88∗∗∗ (−11.73) −.83∗∗∗ (−4.36) lnEMP −.06 (−.47) −.03 (−.27) .01 (.08) −.02 (−.13) HHI 1.33 (.56) .65 (.28) 1.38 (.57) .76 (.31) DI .078 (.07) −.40 (−.35) −.51 (−.45) −.48 (−.40) GC .14 (.26) .28 (.54) .41 (.76) .31 (.57) Group2 .33 (1.17) .29 (1.06) .25 (.92) .33 (.95) R2 0.71 0.72 0.73 0.72 Obs. 108 108 108 108 F-statistic for the joint significance test (Prob>F) lnρ, lnρ× (1/ε) 2.68∗ 1/ε, lnρ× (1/ε) 6.98∗∗∗ lnρ, lnρ× (1/ε) , (ln ρ)2 , (ln ρ× 1/ε)2 .79 1/ε, lnρ× (1/ε) , (1/ε)2 , (ln ρ× 1/ε)2 4.42∗∗∗ LR test /χ2 5.76∗∗ 4.95 *** Significant at the 1% level, ** at the 5% level, and * at the 10% level (t statistics in parentheses) a: The dependent variable is used to proxy the enforcement policy. 47 Chapter 4 Determinants of Environmental Political Contribution 4.1 Introduction Is environmental protection for sale? There have been overwhelming concern and evidence that pro-environment policies are obstructed by politics (e.g., Pittman, 1977; Kraft and Vig, 200974; Mixon, 1995; Cropper et al., 1992; Pashigian, 198575; Damania et al., 200376). In this paper, I first construct an index of environmental political contribution (EPC) – the campaign contri- bution presented to the congress exclusively for environmental issues, which serves as the direct evidence of environmental protection for sale (EPFS) – to measure the environmental political activity. The data show that there 74Kraft and Vig (2009) argue that “intense opposition to environmental and natural resource policies arose in the 104th Congress (1995-1997), when the Republican Party took control of both the House and Senate for the first time in forty years...pitched battles over environmental and energy policy continued in every Congress through the 110th (2007-2009), and they were equally evident in the executive branch as the Bush White House sought to rewrite environmental rules and regulations to favor industry...” 75Mixon (1995) provides evidence that the ratio of the number of registered lobby- ists in the state population has an effect on the degree of an environmental protection agency (EPA) citation for carbon emissions standards; Cropper et al. (1992) indicate that comments in the regulatory political process by grower organizations significantly reduced the probability of cancellation of certain pesticide; Pashigian (1985) points out that votes from the South and the West with higher growth rates and superior air quality oppose the environmental policy of prevention of significant deterioration in the locational competition. 76Damania et al. find that corruption reduces environmental policy stringency in a cross-country analysis. 48 4.1. Introduction is a substantive variation across industry and time in the intensity of EPC (EPC/employment) as shown in Figure 4.1.77 I intend to identify what explains the variation across industries in the intensity of EPC. Figure 4.1: The Variation of the EPC Intensity I explore the role of the enforcement policy stringency in explaining the variation. The intuition is as follows. Although the EPC presented to the Congress is targeted directly on environmental legislation/regulation rather than the enforcement policy set by the environmental protection agency (EPA), the enforcement policy affects the marginal benefit from contributing the congress for relaxing the legislation/regulation.78 For example, an indus- try that has higher expected sanctions/penalties from violating an emission standard has more to gain from spending a dollar to get the standard low- ered than an industry with lower expected penalties. In this way, I predict that industries facing stricter enforcement policies are more likely to engage in the political activity all else equal. And the enforcement policy has a po- 77Because industries vary a lot in size, the environmental political contribution (EPC) is divided by the number of paid employment. EPC/employment is defined as the EPC intensity in this chapter implying the amount of EPC in dollars made by each employee. The unit is the the U.S. Dollar. The details will be discussed in Section 4.3. 78One reason to test EPFS indirectly this way is that I do not have data on regulation (i.e., the elasticity of violation with respect to regulation). Instead, I have data on the elasticities of violation with respect to enforcement estimated in Chapter 2. 49 4.1. Introduction litical consequence. We then test the prediction on the industry-level panel data of the U.S.A. This chapter builds on prevous empirical work that studies the deter- minants of the industrial political activity. They are based on the theory of regulation (Stigler, 1971; Olson 1965): well-organized groups can exert political influence on a government which maximizes its political support to relax the environmental policy stringency that imposes a deadweight loss on the general voter.79 The industrial political activity is related to the envi- ronmental regulations as well as other government regulations empirically. For example, Gawande and Bandyopadhyay (2000) shows that the tariff bar- rier is a factor that determines the trade-related political contribution. In Pittman (1977), environmental regulations are found to be positively related with total political contributions. In sum, the campaign contributions are used to measure the industrial political activity and the attention is paid to the government regulations themselves as determinants. This work makes two key contributions to the literature. One is the characterization of the environmental political activity using EPC. In the literature, the total campaign contribution has been employed to proxy the industrial political activity (e.g., Pittman, 1977; Grier and Munger, 1991, 1993; Gopoian, 1984)80. However, there are concerns about using the total contributions to evaluate the impact on a certain policy (such as trade pol- icy81 or environmental policy) since total amounts of contributions may be the result of multiple purposes. As argued by Gawande and Krishna (2001), “Taking trade policy as an example, lobbying data come as a bundle so it is not easy to disentangle the purely trade-related component of lobbying data. Although this problem may be alle- 79For the theoretical works that characterize the formation of environmental policy as a result of the interaction between the government and organized lobbying groups, see Fredriksson (1997) and Damania (2001). 80This is because, although payments for political favors can take many forms, campaign contributions from the political interest groups are the most visible and contentious, as argued by Doren et al. (1999). 81In Gawande and Bandyopadhyay (2000) and Gawande (1998), the trade-related po- litical contribution is calculated and employed. But the approach is different from the one that this chapter employs. 50 4.1. Introduction viated by considering a set of industries whose primary lobbying concern is trade protection (e.g., Lopez & Pagoulatos, 1996), it requires more care to do a full cross-sectional study for all of manufacturing, both in the measurement of lobbying as well as its econometric treatment.” I calculate EPC as follows: key members of House/Senate environmen- tal committee/subcommittee were identified. Then, campaign contributions from each corporate PAC (political action committee) to those members were collected and summarized. Finally, individual corporate PAC contri- butions with their SICs were aggregated up to the SIC four-digit industry level. This calculation is based on the insight that PACs target incumbents who have seats on committees with jurisdiction over the PACs’ areas of inter- est or committee membership, as pointed out by many existing works (Grier and Munger, 1991, 1993; Riddel, 2003; Gardner, 1995). A firm’s EPC is sup- posed to be a better measure of its environmental political activity than its total political contribution. The other contribution is to isolate the effect of the environmental en- forcement policy from that of the environmental regulation on the envi- ronmental political contribution using the elasticity of the violation rate. Although the enforcement policy and the environmental policy are deter- mined by separate agencies, the two kinds of policies have many common determinants (e.g. the emission intensity). If the relationship between the enforcement policy and the environmental political contribution arises as a result of these common determinants, it is hard to distinguish the enforce- ment policy’s effect from the environmental policy’s effect. In this work, I use the elasticity of the violation rate with respect to the inspection rate to infer the enforcement policy’s effect on the environmental political contribution. The elasticity of the violation rate is a measure of responsiveness in the industrial pollution violation rate as a result of change in the inspection rate. It is regarded as an exogenous industry characteristic and has been estimated in Chapter Two. When an enforcement agency is constrained by a hard enforcement budget, it tends to target industries with 51 4.1. Introduction larger absolute elasticities of the violation rate. This is because inspections in these industries are more likely to be effective in achieving the enforce- ment’s goal all else equal. I regard the elasticity of the violation rate as a major determinant of the inspection rate and found empirical evidence in Chapter Three. Based on these, I predict that industries with larger ab- solute elasticities of the violation rate are subject to stricter enforcement policies and therefore present more political contributions. Empirically, I also highlight the risk-weighted emission intensity and its interaction term with the inverse elasticity of the violation rate, as well as the industry concentration as determinants of the environmental contribution expenditures. First, the risk-weighted emission intensity is defined as a measure of pol- lutants’ potential damage to the environment and human health per unit of production. It can be regarded as the emission intensity weighted by the damage indicator82. The risk-weighted emission intensity has an effect on the environmental political contribution through two channels: the environ- mental regulation (the direct effect) and the enforcement policy (the indirect effect). For the direct effect, a damaging industry (an industry with a larger risk-weighted emission intensity) is subject to more stringent environmental regulations (e.g. the pollution tax). Then, this industry has incentives to contribute to the congress to relax the environmental policies. For the indirect effect, whether a damaging industry is subject to a strict enforcement policy may be conditional on the elasticity of the viola- tion rate. This is because the damage indicator is a key component of the risk-weighted emission intensity. And I find a complementary effect between the damage indicator and the inverse elasticity in determining the inspec- tion rate in Chapter Three. Therefore, I include an interaction term of the risk-weighted emission intensity and the inverse elasticity in the estima- tion. The underlying mechanism is as follows: when the absolute elasticity 82The damage indicator can be regarded as the damage level per unit of emission, while the risk-weighted emission intensity represents the damage level per unit of output. See Chapter Three for details about the damage indicator. 52 4.1. Introduction of violation rate is large, the inspection of a damaging industry is effective. Although its inspection has to incur a higher inspection cost compared with the inspection of a less damaging industry, the inspection rate is higher for a damaging industry. In other word, the risk-weighted emission intensity is positively associated with the inspection rate. That is, a damaging industry is subject to a higher inspection rate. Furthermore, for this industry, a one- unit decrease in the pollution limit as a result of the political contribution can lead to a larger reduced sanction amount and this industry tends to present more environmental political contribution. Otherwise, when the ab- solute elasticity of violation rate is small, the inspection of an industry with a large damage indicator is not effective and has to incur a higher cost. The enforcement agency may be reluctant to impose a strict enforcement policy. As a result, a damaging industry is not inspected more frequently than other industries and does not contribute more. That is, the indirect effect of the risk-weighted emission intensity on the EPC through the enforcement policy is negative. Thus, the overall effect of the risk-weighted emission intensity is ambigu- ous depending on the magnitudes of the indirect effect and the direct effect. But it is predicted to be positive when the elasticity of the violation rate is large. Second, the industry concentration measuring obstacles to collective ac- tion is an important factor of the environmental political contribution. Pol- luting firms that have common interest in changing certain environmental policy usually organize and form a lobby group to present the contributions. Based on the lobbying function in Gawande (1998), I predict that industries that are less concentrated are hard to overcome the difficulty in collective action and thus present less environmental political contributions. The empirical findings using the environmental political contribution as the dependent variable are summarized as follows. (1) The net effects of the absolute elasticity of violation rate on the environmental political contribu- tion, evaluated at most industries’ risk-weighted emission intensity levels, are positive. This implies that a damaging industry is subject to a higher inspection rate and tend to make more contributions. In particular, at the 53 4.1. Introduction sample mean level of the risk-weighted emission intensity, one standard de- viation increase in the inverse elasticity would approximately increase the natural log of the environmental political contribution intensity by 0.35. (2) The net effect of the risk-weighted emission intensity is positive as long as the absolute elasticity of the violation rate is large enough. One example is that one standard deviation increase in the natural log of the risk-weighted emission intensity would lead to a 0.024 increase in the natural log of the en- vironmental political contribution intensity, evaluated at the median value of the inverse elasticity. (3) The industry concentration affects EPC (intensity) significantly and positively which is consistent with existing literature. In addition, I repeat the estimations, but replace the environmental po- litical contribution by the House environmental political contribution and the total political contribution as the dependent variables respectively. The results using the House environmental political contribution are similar with those using the environmental political contribution, both in terms of the estimated magnitude and the significance level. But when I use the total political contribution as a measure of the environmental political activity, the significance levels of the estimated coefficients on some key independent variables are reduced. This suggests that the environmental political con- tribution constructed in this work serves as a better measure than the total political contribution in finding evidence for the roles of the elasticity of the violation rate and the risk-weighted emission intensity. The rest of the chapter is organized as follows. In Section 4.2, I derive the lobbying function to identify the determinants of EPC. In Section 4.3, I describe how to construct the environmental political contribution and sum- marize its statistics. Section 4.4 introduces the empirical specification and describes data sources. Section 4.5 presents the empirical results. In Section 4.6, I conduct the robustness checks. Conclusion is provided in Section 4.7. Some supplementary data descriptions are contained in Appendix C. 54 4.2. Theoretical perspective 4.2 Theoretical perspective The following simple theoretical model is to shed light on the factors that affect each lobby group member’s private contribution amount in a multi- agent system. I emphasize the roles of the enforcement policy stringency and the lobbying organization. A political economy is composed of a congress, an enforcement agency and polluting firms. The congress formulates the environmental regulation which is the emission limit z. I assume, for simplicity, that the emission limit is the same for all firms in each industry. The emission limit z depends on the total campaign contribution amounts presented to the congress. This is because the congress cares about both the social welfare and contributions83, and so it is willing to adjust the emission limit away from the value that maximizes social welfare in exchange for more political contributions. The enforcement agency sets the enforcement policy – the sanction level s for each unit of violation (the emission amount z that exceeds the emission limit z). Because the campaign contributions are presented to the congress, their amounts do not affect the enforcement agency’s decision. Both of the emission limit and the sanction rate are the same for all firms in each industry. Polluting firms that have common interests in changing the emission limit z could organize and form a lobby group. The total contribution amount presented by each lobby group to the congress is the sum of its mem- bers’ private provisions of campaign contribution. I assume z = log ( ∑ Λ−i + Λi), where Λi is the campaign contributions presented by firm i and ∑ Λ−i is the total campaign contributions by contributing firms except firm i. This func- tion shows that the emission limit level depends on the total contribution amount ( ∑ Λ−i + Λi). Given the contribution amount ∑ Λ−i by other firms in this lobby group, firm i independently decides its individual contribution amount Λi. An increase in Λi can lead to a larger z. The net cost to contributing firm i, Gi, is composed of the total sanction 83This welfare function is common in the political economy literature (e.g. Grossman and Helpman, 1994). 55 4.2. Theoretical perspective and its own contribution amount. It takes the following form based on Gawande (1998), Min Λi Gi = s [ z − log (∑ Λ−i + Λi )] + Λi where z is the total pollution level. I assume that the contribution decision is independent of the production decision so that z is regarded as a constant in this political contribution minimization problem. And it is the same for all firms in an industry.84 The emission limit z is also the same for all firms in each industry. Therefore, an individual firms’ net cost of making a contribution depends on its excess pollution (z − z) which is symmetric for all firms in an industry. Given the sanction rate s, each member of a lobby group decides its con- tribution amount. Taking first order condition and assuming each protec- tionist firm is of the same size (the number of equal-size-equivalent firms in an industry n can be approximately measured as the inverse of the Herfind- ahl index of that industry 1/H), individual firm’s contribution is shown as the following85, 1 = s/nΛi In the equation above, the LHS is the marginal cost of contribution, while the RHS is the marginal benefit of contribution. The marginal benefit is a linear increasing function of s. That is, for an industry with a larger s, the marginal benefit of contribution is larger at the same amount of EPC, Lambdai. Given the constant marginal cost of contribution, the firm tends to contribution more. The variant of this lobbying function by log- 84I am assuming firms in each industry producing the same amount of output and emissions so that z is not indexed by i. In this setup, I assume that firms make emission decisions before they make the contribution decisions. When they make the emission decision, they are symmetric and I do not consider this step here. When they make the contribution decision, their behaviors are strategic, as shown by the minimization problem above. 85The first order condition with respect to Λi is the following, − s∑ Λ−i + Λi + 1 = 0. Because firms are assumed to be symmetric in making the contribution decision and there are n firms, ∑ Λ−i+ Λi is equal to nΛi. Therefore, this first order condition is rearranged to be 1 = s/nΛi. 56 4.2. Theoretical perspective transformation and linear approximation is as follows86, ln Λi = lnS +H (4.6) Proposition 2 summarizes the prediction. Proposition 2 All else equal, firms in an industry that is subject to a more stringent enforcement policy tend to contribute more to relax the emission limit. Then, I have the following Lemma based on Prosposition 1 in Chapter Three and Proposition 2. Lemma 1 Industries with larger absolute elasticities of the violation rate with respect to the inspection rate tend to contribute more. Here, the elasticity of the violation rate is a measure of responsiveness in the industrial pollution violation rate as a result of change in the inspection rate. As stated in the Proposition 1 in Chapter Three, if the enforcement agency maximizes social welfare subject to a hard budget constraint for its enforcement activities, the inspection rate will be higher in those industries with a higher elasticity of the violation rate. And as the industries are subject to more frequent inspections, they tend to contribute more. Con- sequently, the absolute elasticity of the violation rate is predicted to be positively associated with EPCI all else equal. Equation 4.6 also shows clearly that the industry concentration measur- ing obstacles to collective action as indicated by H is an important factor of contribution, which is summarized in the following proposition. Proposition 3 The industry concentration affects the average contribution positively. 86I estimate the log-log version of the first order condition as shown below, ln Λi = ln s + ln 1 n . Because firms are assumed to be symmetric, H = 1 n . Then, the equation above becomes ln Λi = ln s + lnH. In this work, I allow the industry concentration to enter the specification linearly as most empirical works do, and the specification becomes ln Λi = ln s+H. 57 4.3. Descriptive analysis of environmental political contribution 4.3 Descriptive analysis of environmental political contribution This section provides the methodology for constructing the environmental political contribution and summarizes its variation across industries. As argued, this serves as the evidence that the political pressure to distort the environmental policy exists, and will be used for estimating Equation 4.6 as the dependent variable. 4.3.1 Measuring environmental political activity Many existing works have given insights into the candidate characteris- tics that political action committees prefer when they make funding deci- sions. As stated by Riddel (2003), many reduced-form models of PAC fund- ing choice include legislator characteristics such as party affiliation, voting records, committee membership, seniority, and state-specific data pertaining to each legislator to explain contributions to candidates from various special interest groups such as agriculture, labor, and oil. In particular, Gardner (1995) argues that agriculture PACs target funds to where they have the highest payoffs. His results demonstrate the importance of the senate key committees. Agricultural PACs will contribute more to senators on key com- mittees.87 Similarly, according to Grier and Munger (1991, 1993), corporate, union, and trade association PACs target incumbents who win by moder- ate margins, have voted sympathetically, and have seats on committees with jurisdiction over the PACs area of interest. Based on these insights, I first obtain the key House/Senate environ- mental committee/subcommittees whose jurisdictions are related with En- vironmental issues from the League of Conservation Voters. They include Subcommittee on Labor, Health and Human Services, Education, and Re- lated Agencies in Committee on Appropriations; Subcommittee on Envi- ronment and Hazardous Materials in Committee on Energy and Commerce; 87Cotton interest groups contribute more to agricultural appropriations subcommittee members than they contribute to nonmembers. 58 4.3. Descriptive analysis of environmental political contribution Subcommittee on Energy and Resources in Committee on Government Re- form; Committee on Resources; Subcommittee on Environment, Technol- ogy, and Standards in Committee on Science and Subcommittee on Wa- ter Resources and Environment in Committee on Transportation and In- frastructure. Then, from the U.S. Government Printing Office, I find the name lists of the members of each key House/Senate environmental Com- mittee/subcommittee. Second, each PAC is then matched against the COMPUSTAT database and various data sources to obtain its SIC code. This will be used for aggregation to the industry level. Third, I collect the campaign contributions presented by each corporate PAC88 to each member in the key committees/subcommittees. The amount of aggregated contribution by each corporate PAC to all the members in the key committees/subcommittees indicates the level of each corporate’s political activity targeting on environmental issues. These data of campaign contributions are available in the Federal Election Commission. Finally, I merged individual corporate PAC contributions with their SICs and then aggregated up to the four-digit industry level. Thus, the total environmental political contribution for each industry (the sum of the con- tributions received by all the candidates in the key environmental commit- tees/subcommittees presented by the corporate PACs in this industry) is obtained. The total environmental political contribution is then divided by the number of PAC to calculate the environmental political contribution per PAC. Because industries vary a lot in size, the environmental contribution is scaled by the number of paid employment. The data source of the number of 88Grier et al. (1994)[36] state: “It is useful to distinguish PACs sponsored by corpora- tions and the trade association PACs that represent the same industry. corporate PAC contributions at the industry level are important in their own right for at least three rea- sons: first, trade associations are subject to the statutory limit of $10,000 per election cycle per candidate. Second, we address collective action directly, by explaining differences in industries’ ability to overcome free-rider problems and induce corporations to act.; Since the pattern of contributions observed just one firm at a time could be consistent with either pure cooperation or purely atomistic behavior, we use the industry as the unit of analysis.” 59 4.3. Descriptive analysis of environmental political contribution paid employment proxying the industry size is the 1997 Economic Census. This scaled environmental contribution is defined as Environmental Political Contribution Intensity (EPCI) in this paper and will be used as the main dependent variable. The details of the data sources and methodology are presented in Ap- pendix C.2. Meanwhile, I calculate the total political contribution intensity (PCI) similarly. Although EPCI is a better proxy of environmental political activ- ity, PCI contains the information of EPCI and will be used for comparison. EPCI H is the intensity of the environmental political contribution to the candidates in the key House environmental committees/subcommittees. The statistic analysis in this section is based on data covering four elec- tion cycles 1999’-2006’. It is noteworthy that I focus on the manufacturing sector (2000 to 3999 SIC code) only. This is not only because of the data richness, but also because a large share of the contributions are presented by the PACs in this sector. Specifically, the corporate PACs in manufacturing sector captures around 35 percent of the corporate PACs listed in the Fed- eral Election Commission data and recorded with a SIC code in one election cycle. 4.3.2 Trend analysis Table 11 shows the growth of campaign contribution per PAC.89 The sample comprises 124 industries in the manufacturing group. Average contributions per PAC across industries have increased from around $50 thousand in 1999 to more than $80 thousand in 2006. Both the average environmental contri- butions per PAC, and those to the House candidates only, grow significantly. The largest environmental contribution per PAC by a single industry rises from $133500 to $22974090. 89The environmental campaign contribution per PAC is not the dependent variable that will be used later. The dependent variable is the environmental campaign contribution intensity, which is the ratio of the EPC over the paid employment. 90The expenditures are not adjusted for inflation. This chapter focuses on the variations across industries, not those over time. 60 4 .3. D escrip tive an a ly sis of en v iron m en tal p olitical con trib u tion Table 4.1: Environmental Political Contribution to Congressional Candidates (124 Industries in Manufacturing Group) Election Cycle (year) Average Nonzero Contributions per PAC($) Average Nonzero Environmental Contributions per PAC($) Largest Single-Industry Environmental Contributions per PAC($) EPC per PAC to Members in House Committees($) 1999-2000 53768.99 20225.72 133500 14447.62 2001-2002 52605.98 23266.94 170730.6 15736.58 2003-2004 64551.49 27344.44 202603.2 18741.86 2005-2006 82203.08 33345.63 229740 21640.89 61 4.4. Empirical specification and data sources There are 160 industries with EPC data available in the election cycle 2005-2006.91 Table 4.2 lists the ranks of industries according to the total environmental contribution (EPC). These show the large variation across industries. Meanwhile, The mean value of EPC per PAC is 33345.63, and that of PC per PAC is 82203.08. This implies that about 40% of the total political contribution presented by a PAC is accounted as the contributions for environmental purposes. This is considered as the upper limit of the proportion of environmental political contribution in total political contri- bution. The reason is that the key environmental committee members may have positions in other committees so that the contributions could be pre- sented for other purposes as well. In sum, this section constructs the data on EPC to provide evidence that government cares about both the social welfare and EPC and trades political protection for EPC. Given this, the following studies what drives the variation of the environmental political contribution across industries. 4.4 Empirical specification and data sources The reduced-form specification is established based on Equation 4.6, which suggests the central roles of the inverse elasticity of violation rate with re- spect to inspection rate 1 ε (via its effect on the inspection rate) and the industry concentration H in determining the environmental political contri- bution. The estimation is based on the following specification: lnEPCIj,t = α1 ln scorej,t + α2 1 ε j + α12 ( ln scorej,t × 1 ε j ) + α3HHIj +α4PT ratej + α5ISOj + α6 lnEMPj + α7GCj,t +α8DIj,t + α9Groupj + α10Y earj + εj (4.7) where ln score represents the natural log of the risk-weighted emission in- tensity, 1 ε is the reciprocal of the elasticity of the violation rate, HHI is the 91The ranks in other election cycles do not differ from those much. 62 4.4. Empirical specification and data sources Table 4.2: Industries in Manufacturing Group Ranked by Environmental Political Contribution Amounts, 2005-2006 5 Industries with the Most EPC (160 industries) Industry Name EPC 2834 Pharmaceutical Preparations 2529469 2911 Petroleum Refining 1621337 3721 Aircraft 1148700 3812 SDNGAN Systems and Instruments 1118461 3711 Motor Vehicles and Passenger Car Bodies 1024220 5 Industries with the Least EPC Industry Name EPC 3949 Toys and Sporting Goods 49 2741 Miscellaneous Publishing 700 3699 Misc. Electrical Equipment&Supplies 1000 3421 Cutlery, Handtools, and Hardware 1000 3569 General Industrial Machinery 1000 *1987 US SIC division classification 5 Industries with the Most EPCI (142 industries) Industry Name EPCI 2021 Creamery Butter 81.28 2076 Vegetable Oil Mills, Except Corn, Cottonseed, and Soybean 43.55 2111 Cigarettes 28.3 2911 Petroleum Refining 24.76 2834 Pharmaceutical Preparations 22.50 5 Industries with the Least EPCI Industry Name EPCI 3949 Toys and Sporting Goods 0.0007 2741 Miscellaneous Publishing 0.0089 3089 Plastics Products, NEC 0.01 3569 General Industrial Machinery 0.02 2657 Folding Paperboard Boxes, Including Sanitary 0.04 *1987 US SIC division classification 63 4.4. Empirical specification and data sources industry concentration, PT rate is the ratio of the facilities that participate the voluntary program (performance track), ISO is the number of firms that voluntarily adopt the international standard ISO14001, EMP is the paid employment, GC is the geographical concentration, DI is the diverse industry, and Group is the group fixed effect and Y ear is the year dummies to capture the fixed year effects. According to Lemma 1, I predict the coefficient of the inverse elasticity of violation rate 1ε is positive. It is noteworthy that I am using the elasticity of the violation rate to infer the relationship between the enforcement policy and the political contribution level. That is, the enforcement policy does not appear in the regression directly. If I include the enforcement policy in the regression, it is hard to isolate the enforcement policy’s effect from the environmental regulation’s effect. Although the enforcement policy and the environmental regulation are determined by separate agencies, the two kinds of policies have many common determinants (e.g. the emission intensity). The correlation between the enforcement policy and the environmental po- litical contribution may arise as a result of these common determinants. As shown by the specification 4.7 above, I also control for the natural log of the risk-weighted emission intensity ln score and include its interaction term with the elasticity of the violation rate ln score × 1ε . The reasons are as follows. The risk-weighted emission intensity score is defined as a measure of pollutants’ potential damage to the environment and human health per unit of production. In the US EPA’s Risk-Screening Environmental Indicators (RSEI Version 2.1.5),92 RSEI contains “risk-related results”, which imposes a risk score on industries at different SIC levels. The toxicity, surrogate dose, and population components are multiplied to calculate this risk score. It is used to assess the potential impact of industrial releases. The “risk- related results” are scaled by paid employment93 and is denoted by “score” 92See Appendix B.2 for details. Data of the risk-weighted emission intensity is available with the SIC code. 93It can also be scaled by value added. The regression results are similar if EPC is also scaled by value added to calculate EPCI. 64 4.4. Empirical specification and data sources in this chapter94. The risk-weighted emission intensity can be regarded as the emission intensity weighted by the damage indicator (which is the potential damage per unit of emission). The risk-weighted emission intensity has an effect on the environmental political contribution through two channels: the environmental regulation (the direct effect) and the enforcement policy (the indirect effect). For the direct effect, a damaging industry (an industry with a larger risk-related emission intensity) is more likely to be subject to a stringent environmental regulation (e.g. the pollution tax) directly. Then, this industry has incen- tives to contribute to the congress to relax the environmental regulation. For the indirect effect, if a damaging industry is subject to strict enforcement policies, a one-unit decrease in the pollution limit as a result of the political contribution can lead to a larger reduced sanction amount for this indus- try, so that this industry tend to contribute more. In this case, the overall effect of the risk-weighted emission intensity on the environmental political contribution is positive. However, if a damaging industry is subject to lax enforcement policies, this industry tend to make less contribution. And the overall effect of the risk-weighted emission intensity is ambiguous. In order to investigate further when the effect of the risk-weighted emis- sion intensity on the inspection rate is positive so that the effect of the risk-weighted emission intensity on the environmental political contribution can be identified, I add an interaction term of the risk-weighted emission intensity and the inverse elasticity in the estimation. In Chapter Three, it has been found that there exists a complementary effect between the dam- age indicator and the inverse elasticity in determining the inspection rate. Because the damage indicator is a key component of the risk-weighted emis- 94This is similar to the measure of environmental exposure in Antweiler (2003). It com- bines a firm’s composition and toxicity of emissions and its location that determines the size of the population at risk with the firm’s size and intensity of pollution. This measure of environmental exposure is utilized as one of firm characteristics to investigate its effect on firm’s abatement effort. This effect is used to back out the effect of green regulatory threat which is not directly measurable. Because environmental exposure triggers regula- tion, it has been shown that the effectiveness of threat depends on environmental exposure of a firm. It also depends on abatement ladder rung of a firm and government’s incentive scheme as argued in this paper. 65 4.4. Empirical specification and data sources sion intensity, it is hypothesized that the effect of the risk-weighted emission intensity on the inspection rate is conditional on the elasticity of the vio- lation rate. The underlying mechanism is as follows: when the absolute elasticity of violation rate is large, the inspection of a damaging industry is effective. Although its inspection has to incur a higher inspection cost compared with the inspection of a less damaging industry, the inspection rate is higher for a damaging industry. In other word, the risk-weighted emission intensity is positively associated with the inspection rate, hence the environmental political contribution, when the absolute elasticity of vi- olation rate is large. Otherwise, when the absolute elasticity of violation rate is small, the inspection is not effective and has to incur a higher cost. The enforcement agency may be reluctant to impose a strict enforcement policy. As a result, a damaging industry is not inspected more frequently than the less damaging industry. That is, the indirect effect is negative. As the indirect effect dominate the direct effect, a damaging industry may not make a larger contribution. I describe the other variables used in the analysis as follows. The number of paid employees (EMP) is used to measure industry size and is from the 1997 Economic Census.95 The 1992 Census of Manufactures report MC92- S-2, “Concentration Ratios in Manufacturing”, is the data source for HHI (Herfindahl Hirschmann Index) that characterizes the industry concentra- tion96. DI and GC may also impact the collective action to seek political influ- ence because they are measures of the extent to which the industry has com- mon interest. Measures of Diverse industry (DI) and Geographic Concen- tration (GC) were constructed as described by Grier, Munger and Roberts (1994). The number of segments is reported by each firm, up to a maximum 95The Economic Census profiles American business every 5 years and the 2002 data are available. However, the 2002 Economic Census is based on North American Industry Classification System (NAICS). Given the violation rate is based on SICs, the conversion of employment based on NAICS into that based on SICs may lead to some bias. The 1997 data are available in both NAICS and SICs. And since the employment number is used to control for industry size which is relatively stable over short periods, I choose the 1997 data. 96The 1997 data are available but are classified by NAICS instead of SIC. 66 4.4. Empirical specification and data sources of 10 in COMPUSTAT industrial segment file. The data were averaged by industry (mean=1.7, s.d.=0.65) and a diverse industry is defined as “one with mean number of products more than two s.d. above the sample aver- age, that is, all industries whose firms average more than three products line are coded 1.0 and the others 0.00”. Because the data vary little at 4-digit level, I compiled them into 3-digit level data. And the data cover the period of 1998-2006. Industries with greater product diversity have weaker com- mon interests among firms within the industry, so we expect contributions to be lower. Geographic concentration is calculated as ∑ i ( Salesi Sales )2 for each industry where i denotes state. The data of sales (DATA12) in each state were collected from COMPUSTAT as well. GC is a measure of whether an industry has good alternatives to contributions as means of gaining political influence (e.g., lobbying, direct appeals to voters). If an industry is located entirely in a single state, its employees are an important voting block for legislators in that state. The expected sign for the coefficient on GC is negative, since votes can substitute for contributions. I include PT rate and ISO to take into account of the competition be- tween opposing lobbies and pressures from other groups. Performance-track is a program that firms can voluntarily participate. The “Enforcement & Compliance History Online (ECHO)” publicly provided by the U.S. EPA records the facilities that are performance track members. The PT rate is calculated as the ratio of the number of facilities the are performance track members in total facilities inspected within the last 5 years. Because the variation at the 4 digit is too small, I aggregate the data according to the SIC code to the 3-digit level. ISO is the number of firms that cer- tify their environmental management system (EMS) to the international standard of ISO14001, scaled by the number of paid employees, and the data source is Darnall (2003).97 The participation of the voluntary pro- gram and the adoption of voluntary standard are both indicators of firms’ 97It is described in this paper that “lists of all ISO 14001-certified facilities (1996-1999) were obtained from Global International Quality Group and McGraw-Hill. In addition, the websites of state environmental agencies were searched for additional ISO 14001 certified facilities.” However, I do not have the time series, and the data used in my work are the average values across industries only found in the descriptive statistics table of Darnall’s. 67 4.4. Empirical specification and data sources voluntary abatement behavior. It has been argued that conflicts between industry and environmental group’s pressure (such as green consumers and ecologist groups) are incentives, at least partly, for voluntary abatement be- havior in the literature (e.g., Arora and Gangopadhayay, 1995; Vidovic and Khanna, 2007; and Blackman and Bannister, 1998). Thus, higher PT rate and ISO are employed to measure higher level of political strategic compe- titions among lobby groups and greater pressure from environmental groups and the community. It implies that industries with more intense competi- tions and greater pressure have to contribute more. The dataset combining information from several sources is summarized below in Table 4.3 and Table 4.4. 68 4 .4. E m p irical sp ecifi cation an d d ata sou rces Table 4.3: Variable Definition and Data Sources III Variable Description Sources EPCI =Environmental campaign contributionThe number of paid employment FEC and various sources 4 election cycles over 99’-06’ PCI = Total campaign contributionThe number of paid employment FEC and various sources 4 election cycles over 99’-06’ EPCI H =PC to candidates in the key House environmental committeeThe number of paid employment FEC and various sources 4 election cycles over 99’-06’ score = Risk-related resultsThe number of paid employment RSEI, 1996’-2005’ ε A measure of responsiveness in the pollution violation rate as a result of change in enforcement policy Chapter Two, no time series w = Production workers wagesThe value of industry shipments 1996 ASM, 1996’ k = New capital expendituresThe value of industry shipments 1996 ASM, 1996’ Material = Cost of materialsThe value of industry shipments 1996 ASM, 1996’ Energy =Cost of purchased fuels and electric energyThe value of industry shipments 1996 ASM, 1996’ EMP The number of paid employment 1997 Economic Census, 1997’ HHI Industrial concentration normalized between 0 and 1 1992 Economic Census, 1992’ DI =1 for a large number of product lines =0 for a small number of product lines Industrial segment file in COMPUSTAT Grier et al.(1994), 1998’-2006’, 3-digit GC = ∑ i ( Salesi Sales )2 (i: state) COMPUSTAT, Grier et al.(1994), 1995’-2006’ PT rate =The number of facilities that are Performance Track membersThe number of facilities ECHO, 3-digit, no time series ISO =The number of firms that certify their EMSs to ISO14001The number of paid employment Darnall (2003), 2-digit, no time series69 4 .4. E m p irical sp ecifi cation an d d ata sou rces Table 4.4: Summary Statistics III Variable Number of Mean Standard Minimum Maximum Observations Deviation Industry Concentration (HHI) 447 0.066 0.06 0.000056 0.297 Industry Diversity (DI) 3950 .04 .20 0 1 Industry Size (lnEMP ) 419 9.95 1.11 6.20 13.18 Geographic Concentration (GC) 5302 .40 .24 .09 1 Damage Score (ln score) 3709 18.78 3.28 1.02 27.57 Inverse Elasticity of the Violation Rate(1/ε) 111 -4.0 2.19 -11.3 -0.9 Environmental Political Contribution Intensity (EPCI) 563 2.86 7.00 .0007 81.28 Contribution Intensity (PCI) 607 7.26 18.65 .0007 213.74 House EPCI (EPCI H) 540 1.77 4.12 .0009 50.08 Performance-Track Member (PT rate) 94 1.0 1.26 .019 7.17 ISO14001 (ISO) 20 .08 .05 .01 .18 Labor Share (w) 456 .11 .05 .01 .32 Capital Share (k) 450 .03 .03 .001 .34 Material Share (Material) 455 .50 .13 .17 .90 Energy Share (Energy) 455 .02 .03 .002 .21 70 4.5. Empirical results 4.5 Empirical results The results are presented in Table 4.5. The three columns of Table 4.5 use different political activity measures as the dependent variables. They are EPCI (Environmental Political Contribution Intensity: the sum of the campaign contribution amounts made to candidates in the key environmen- tal committees weighted by the number of paid employment), EPCI H (Environmental Political Contribution Intensity: the sum of the campaign contribution amounts made to candidates in the key HOUSE environmental committees weighted by the number of paid employment), and PCI (Polit- ical Contribution Intensity: the sum of the campaign contribution amounts weighted by the number of paid employment) respectively98. Although the dataset covers four election cycles for the dependent variable, 1999-2000, 2001-2002, 2003-2004 and 2005-2006, many of the independent variables are not time-varying. I use the pooled OLS and control for the year dummies. In all regressions, the political pressure (PT rate and ISO), some indus- try heterogeneities (lnEMP , GC, DI), and the group effect (Group) are controlled for. In Column (1), I use the environmental political contribution intensity to measure the political activity and its natural log is the dependent vari- able (lnEPCI). The result shows that the risk-weighted emission intensity ln score has a positive estimated coefficient on the environmental political contribution intensity and is strongly significant at the 1% level. The esti- mated coefficient on the reciprocal of the elasticity of violation 1 ε is negative and significant at the 1% level. Their interaction term ln score × 1 ε has a positive and significant estimated coefficient. I calculate the net effect of the reciprocal of the elasticity of violation on EPCI first. The net effects are positive evaluated for most of the industries (around 87 percent). This is consistent with Lemma 1. In particular, at 98EPCI H is a subset of EPCI because the campaign contribution amounts made to candidates in the key Senate environmental committees are excluded. EPCI is a subset of PCI because the campaign contribution amounts made to candidates that are not in the key environmental committees are excluded. 71 4.5. Empirical results the sample mean level of ln score99, one standard deviation increase in the 1 ε would approximately increase the environmental political contribution intensity by 0.35.100 The effect of ln score on lnEPCI depends on the magnitude of the elas- ticity of the violation rate. That is, the net effect of ln score is conditional. It is calculated by using the estimated coefficients on ln score and ln score× 1 ε . When the absolute elasticity of violation rate is large, the effect of ln score is positive. For example, one standard deviation increase in ln score at the median value of 1 ε would approximately increase lnEPCI by 0.024.101 This shows that the net effect of the risk-weighted emission intensity at the me- dian value of the inverse elasticity is positive. It implies that, for industries whose inverse elasticities are at the median value, the damaging industries are subject to more stringent environmental policy and inspections. They have incentive to make more contribution. When the absolute elasticity is small, the effect of ln score may become negative. For example, The esti- mated coefficient of ln score at the mean value of 1 ε (= −4.0, lower than its median value) is negative. HHI’s estimated coefficient is significantly positive at the 1% level, which is as predicted. When HHI is low, it implies this industry is less concentrated, so that the behavior of each firm is less noticeable. Hence, the free-rider problem is more serious and each firm contributes less. Fur- thermore, the large number of similar-sized firms complicates formation and enforcement of agreements over contribution strategies. That is, the cost of collective action is high. In addition, less concentrated industries do not have as much market power to earn maximal profits as highly concentrated industries. Less concentrated industries are not easy to overcome the dif- ficulty in collective action and thus present little environmental political contribution. This result is consistent with the existing literature. 99The risk-weighted emission intensity has been scaled to keep its natural log positive. 100The calculation is as follows: [−0.6 + 0.04 × 19]×2.2 = 0.352, where the sample mean of ln ρ is 19, the standard deviation of 1 e is 2.2 101The net effects were calculated as follows: [0.15 + 0.04× (−3.57)] × 3.28 = 0.024, where median( 1 e ) = −3.57 and the standard deviation of ln score is 3.28. 72 4.6. Robustness checks In Column (2), I use the environmental political contribution presented to the key House environmental committees/subcommittees per PAC (scaled by the number of paid employment) to measure the political activity and its natural log is the dependent variable (lnEPCI H). The House environ- mental committee members are 40% of the total committee members that accepted contributions from the listed PACs in the manufacturing group. The Senate has a higher ratio that is about 50% because many candidates are performing duties in multiple committees. That is, the contributions to the key Senate committee members are more likely to target on non- environmental issues than the contributions to the key House committee members. Nevertheless, the results are similar to that in Column (1) of Table 4.5 both in terms of the estimated magnitude and the significance level. Column (3) reports the results when the total political contribution in- tensity is used as a measure of the environmental political activity. The dependent variable is lnPCI. The estimated coefficients on 1 ε and ln score are not as significant as those in Columns (1) and (2). This suggests that EPCI is a better measure than PCI for finding evidence for Propositions 2 in this framework. 4.6 Robustness checks I conduct five robustness checks based on the regression in Column (1) of Table 4.5 and report the results in Table 4.6. In column (1) of Table 4.6, the main determinant of the inspection rate 1 ε is omitted in the regression to focus on the effects of the industry concentration (HHI) and the risk- weighted emission intensity (ln score) on the environmental contribution intensity (lnEPCI). And the risk-weighted emission intensity (ln score) is instrumented with the damage indicator (ln ρ) and the input shares (lnwage, lnmaterial, ln k and ln energy) to alleviate its potential endogeneity prob- lem. The estimated coefficients on ln score and HHI are both significant and positive. The magnitude of HHI’s estimated coefficient is stable com- pared with those in Table 4.5. The R2 is about 0.3, which is 0.1 less than 73 4.6. Robustness checks Table 4.5: Results of Environmental Political Contribution Intensities Re- gressions: Election Cycles of 2000, 2002, 2004 and 2006 Dependent Variable is lnEPCI lnEPCI H lnPCI Independent Pooled OLS Variable (1) (2) (3) ln score .15∗∗∗ (3.04) .15∗∗∗ (2.99) .08 (1.61) 1/ε −.60∗∗∗ (−3.23) −.54∗∗∗ (−2.93) −.45∗∗ (−2.26) ln score×1ε .04∗∗∗ (4.03) .04∗∗∗ (3.67) .03∗∗∗ (2.86) lnEMP −.61∗∗∗ (−8.43) −.61∗∗∗ (−8.26) −.56∗∗∗ (−7.28) HHI 4.37∗∗∗ (2.92) 4.80∗∗∗ (3.17) 6.31∗∗∗ (3.94) DI .18 (0.56) .12 (0.37) .54 (1.56) GC −.15 (−0.42) −.28 (−0.80) .09 (0.25) PT rate .35∗∗∗ (5.52) .34∗∗∗ (5.34) .35∗∗∗ (5.12) ISO 4.00∗∗∗ (2.65) 4.72∗∗∗ (3.08) 4.30∗∗∗ (2.68) Group .16 (.83) .26 (1.34) .33 (1.59) Year Y Y Y R2 0.402 0.398 0.4583 Obs. 372 360 180 *** Significant at the 1% level, ** at the 5% level, and * at the 10% level (t statistics in parentheses) 74 4.7. Conclusions that in Column (1) of Table 4.5. This implies the important explanatory power of the inverse elasticity. Column (2) presents the results using the random-effect estimation. I keep the key control variables only in the regression. The signs and magni- tudes of the estimated coefficients on ln score, 1ε , and ln score×1ε are similar compared with those in Column (1) of Table 4.5. This is not used as the baseline regression because many of the control variables do not have time series. The estimation in Column (3) is the same as that in Column (1) of Table 4.5 except that PT rate and ISO are omitted. The damaging industries may be more likely to participate the voluntary programs. This is to avoid their collinearity with ln score. In Column (4), the sample is reduced to contain two election cycles (2003’-2004’ and 2005’-2006’). In Column (5), I employ the weighted least squares. The weights are the value of shipments. The overall results are stable. 4.7 Conclusions This chapter investigates the determinants of the firms’ environmental po- litical activity. I started with the data construction of the environmental political contribution (EPC), which is defined as the political campaign do- nations by firms exclusively for the purposes of environmental issues and is employed to measure firms’ environmental political activity. The con- structed dataset shows that the EPC changes over time and varies signif- icantly across industries. I highlight three factors’ roles in explaining the variation of the environmental political contribution across industries using the U.S. data: the industry concentration, the elasticity of the violation rate, and the risk-weighted emission intensity. The empirical findings are summarized as follows. (1) The net effects of the absolute elasticity of violation rate on the environmental political contribution, evaluated at most industries’ risk-weighted emission intensity levels, are positive. This implies that an elastic industry is subject to a higher inspection rate and tends to make more contributions. In particu- 75 4.7. Conclusions Table 4.6: Robustness of Environmental Political Contribution Intensities Regressions Dependent Variable is lnEPCI Independent IV OLS Random OLS OLS(03’-06’) WLS Variable (1) (2) (3) (4) (5) ln score .07∗∗ (2.39) .15∗∗ (2.21) .18∗∗∗ (3.53) .11 (1.53) .11∗∗ (2.28) 1/ε −.38∗ (−1.65) −.80∗∗∗ (−4.22) −.51∗∗ (−2.05) −.48∗∗∗ (−2.58) ln score×1ε .03∗∗ (2.11) .06∗∗∗ (5.10) .04∗∗∗ (2.59) .04∗∗∗ (3.25) lnEMP −.51∗∗∗ (−7.39) −.41∗∗∗ (−3.38) −.45∗∗∗ (−6.47) −.69∗∗∗ (−6.58) −.67∗∗∗ (−9.15) HHI 5.71∗∗∗ (4.44) 9.77∗∗∗ (3.65) 6.63∗∗∗ (4.37) 1.93 (.86) 4.69∗∗∗ (3.06) DI .13 (0.43) .52 (1.57) .50 (.78) .24 (.76) GC .26 (.84) −.08 (−0.23) −.27 (−0.55) −.20 (−.59) PT rate .32∗∗∗ (5.31) .41∗∗∗ (4.58) .35∗∗∗ (5.35) ISO 2.04 (1.42) 3.73∗ (1.66) 2.91∗ (2.09) Group .43∗∗∗ (2.6) −.01 (−0.03) −.24 (−1.34) −.02 (−.05) .03 (.13) Y ear Y Y Y Y Y R2 0.291 0.307 0.341 0.406 0.407 Obs. 469 372 372 172 372 *** Significant at the 1% level, ** at the 5% level, and * at the 10% level (t statistics in parentheses) 76 4.7. Conclusions lar, at the sample mean level of the risk-weighted emission intensity, one standard deviation increase in the inverse elasticity would approximately increase the natural log of the environmental political contribution inten- sity by 0.35. (2) The net effect of the risk-weighted emission intensity is positive as long as the absolute elasticity of violation rate is large enough. One example is that one standard deviation increase in the natural log of the risk-weighted emission intensity would lead to a 0.024 increase in the natural log of the environmental political contribution intensity, evaluated at the median value of the inverse elasticity. (3) The industry concentration affects EPC (intensity) significantly and positively which is consistent with existing literature. In addition, when I use the total political contribution as a measure of the environmental political activity, the significance levels of the estimated coefficients on some key independent variables are reduced. This suggests that the environmental political contribution constructed in this work serves as a better measure than the total political contribution in finding evidence for the roles of the elasticity of the violation rate and the risk-weighted emission intensity. This chapter could be extended in the following ways. (1) Although the contribution takes effect at the industry level, an empirical examination of individual-firm contribution about the lobbying organization would be interesting. (2) This chapter considers politically organized and contribut- ing industries only. If the complete data were collected, a probit equation could be used to identify which industry tends to be more politically ac- tive/inactive. 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Further evidence from the EPA’s 33/50 program”, Journal of Environmental Economics and Manage- ment, March 2007, Vol.53(2), 180-195 [75] Viscusi, W.K. and R.J. Zeckhauser, “Optimal standards with incom- plete enforcement”, Public Policy, 1070, 27 No.4, 437-456 85 [76] Zardkoohi, A., “On the political participation of the firm in the political process”, Southern Economic Journal, 1985, Vol.51, 804-817 86 Appendix A Appendix to Chapter 2 A.1 The BLP model In the demand function estimation in the empirical industrial organization, the goods characteristics and price determine each goods’ mean value δ to consumers. The total value to individual consumer choosing one goods depends on this goods’ mean value and consumer’s individual taste which is assumed to follow an i.i.d. logit draw given infinite consumers. Here, the mean values for choice between compliance and violation are different. That is, when a firm is in violation, the unit penalty is Rv, other- wise, it has to meet the effluent standard by investing the minimum Rc. The total value to an individual firm choosing to violate depends on Rv with the other violation utility ξv and its individual characteristics which is assumed to follow an i.i.d. logit distribution given infinite firms in one industry. In the original BLP model, the market share for each goods is found. Then, each market share can be sorted over time or according to location as observations. Similarly, in this modified model, I find the violation rate for each indus- try, then I control for industry characteristics to focus on the observations sorted by industries and over time. The difference is that, one of the variation sources in the original model is the goods differentiation. Here, I just focus on one choice, the violation rate. That is, I do not study the compliance rate. 87 A.2. Econometric model of the industry-level violation rate Table A.1: Comparision with the BLP Model Consumer/Goods a b · · · J 1 δa + v1a δb + v1b · · · δJ + v1J 2 δa + v2a δb + v2b · · · δJ + v2J ... ... ... ... ... n δa + vnb δa + vnb · · · δJ + vnJ Industry Firm Compliance Violation i 1 W ic + γ i 1c W i v + γ i 1v i 2 W ic + γ i 2c W i v + γ i 2v ... ... ... ... i ni W ic + γ i nc W i v + γ i nv A.2 Econometric model of the industry-level violation rate Following Train (2003)[71], I show how to derive the equation of aggregate violation rates at industry level in the difference of the welfares and to calculate the elasticities of violation below. Probability of choosing to violate for firm l in industry I is the following according to γ’s density function, Pri,lv = Pr(Flvt > Flct) = Pr(Wvt + γlvt > Wct + γlct) = Pr(γlct < Wvt −Wct + γlvt) = e−e −(Wvt−Wct+γlvt) As a result, the violation rate in industry i is the following, V Rit = ∫∞ −∞ Pr(Flvt > Flct)e −γlvte−e−γlvtdγlvt = ∫∞ −∞ e −e−(Wvt−Wct+γlvt)−e−γlvte−γlvtdγlvt = ∫∞ −∞ e −e−γlvt(e−(Wvt−Wct)+1)e−γlvtdγlvt = ∫∞ 0 e −µ(e−(Wvt−Wct)+1)dµ where µ ≡ e−γlvt , as γlvt →∞, µ→ 0, and as γlvt → −∞, µ→∞. = − e−µ(e −(Wvt−Wct)+1) eWvt−Wct+1 |∞0 = 1 e−(Wvt−Wct)+1 88 A.3. Data of the inspection rate and the violation rate = e Wvt eWct+eWvt e = ∂V R∂IRvt IRvt V R = ∂ e β1IRi,vt+ξivt e λIRi,ct+ξict+e β1IRi,vt+ξivt ∂IRvt IRvt V R = IRvt ∂Wvt∂IRvt (1− V R) = IRvt (1− V R)β1 A.3 Data of the inspection rate and the violation rate Inspection number In ECHO (All Data), I search by the following cri- teria: a four-digit SIC code in Facility Characteristics; “within 5 years since last inspection” in Inspection/Enforcement History. The result is a list of facilities that were inspected within last five years. In each facility’s detailed report, “Compliance Monitoring History” lists the dates for each inspection. A facility could be inspected from zero to multiple times in a year. I count them by years. For example, if there is a “State Conducted FCE/On-Site” on 08/22/2006, the inspection number in 2006 is increased by 1. Then, for each year, the inspection numbers of all facilities listed in the search result are summed up as the inspection number in that year for this industry. Inspection type The Detailed Facility Report includes inspections which were conducted within the last five years. Some inspection types are included in official counts, but italicized inspection types are not part of EPA official counts. In this thesis, I only consider the official counts such as FE - EPA Conducted FCE/On-Site and FZ - EPA Conducted FCE/Off-Site. For a detailed list, please refer to the section ”Compliance Monitoring History” in http://www.epa-echo.gov/echo/dfr data dictionary.html#ih. Violation number In ECHO (All Data), search by the following criteria: a four-digit SIC code in Facility Characteristics; “within 5 years since last inspection” in Inspection/Enforcement History; “formal enforcement actions within 5 years” in Inspection/Enforcement History. The result is a list of 89 A.3. Data of the inspection rate and the violation rate facilities that were inspected and were subject to formal enforcement actions within last five years. In each facility’s detailed report, “Formal Enforcement Actions” lists the dates for each formal enforcement action. I count them by years. For example, if there is a “State Administrative Order Issued” on 08/10/2007, the violation number in 2007 is increased by 1. Then, for each year, the violation numbers of all facilities listed in the search result are summed up as the violation number in that year for this industry. Formal enforcement actions Enforcement actions under the Clean Air Act, Clean Water Act, Resources Conservation and Recovery Act, Emer- gency Planning and Community Right-to-know Act Section 313, Federal Insecticide, Fungicide, and Rodenticide Act, and Toxic Substances Control Act are all included, such as CWA 404 Penalty AO Class I Init, Adminis- trative Order, and Judicial. For the detailed list of the action types, please refer to http://www.epa-echo.gov/echo/dfr data dictionary.html#cea. I do not include the Notices of Violation or Informal Enforcement Ac- tions. As indicated by the EPA, ”in many cases, a notice of violation causes a facility to correct problems and return to compliance. Many notices of violation are not escalated to formal enforcement action because the facility quickly corrects the problem(s) indicated in the notice.”. 90 A.4. First stage results of 2SLS in Table 2.3 A.4 First stage results of 2SLS in Table 2.3 Dependent variable is Independent Column (1) Column (2) Column(3) Variable IR lnEI IR lnEI IR lnEI IR IV .79∗∗∗ (17.55) 1.18∗∗∗ (2.70) .69∗∗∗ (13.02) 2.16∗∗∗ (3.86) .91∗∗∗ (24.16) −.09 (−0.44) lnEMP −.01 (−1.03) −.32∗∗ (−2.50) −.01 (−1.27) −.31∗∗ (−2.50) lnwage −.05∗ (−1.81) −.18 (−0.73) −.05∗∗ (−2.34) −.15 (sl−0.61) lnmaterial .13∗∗∗ (2.77) 3.48∗∗∗ (7.50) .13∗∗∗ (3.02) 3.56∗∗∗ (8.06) lnk .07∗∗ (2.22) 1.69∗∗∗ (5.54) .07∗∗ (2.51) 1.69∗∗∗ (5.79) lnenergy .05∗∗ (2.43) .28 (1.30) .06∗∗∗ (3.21) .17 (0.82) HHI .63∗∗∗ (2.73) −2.81∗∗ (−2.50) .64∗∗∗ (3.10) −2.71 (−1.24) DI −.05 (−0.88) .66 (1.22) −.06 (−0.84) 1.20 (1.65) −.03 (−0.63 −.01 (−0.04) GC .11∗∗ (2.20) .032 (0.06) .11∗∗ (2.34) .08 (0.16) −.12 (−0.89) .50 (0.66) Group2 −.05 (−1.55) −1.96∗∗∗ (−6.89) −.03 (−1.35) −2.07∗∗∗ (−7.58) Year2004 .03 (1.59) −.22 (−1.31) .04∗ (1.75) −.36 (−1.46) .01 (0.60) −.03 (−0.48) *** Significant at the 1% level, ** at the 5% level, and * at the 10% level (t statistics are in parentheses) 91 Appendix B Appendix to Chapter 3 B.1 Proof of equation 3.4 By maximizing Ω subject to the constraint, I have ∂ΩA ∂pi = tivi + piti ∂vi ∂pi − ρi ∂vi ∂pi − tivi − λe ( vi + pi ∂vi ∂pi ) = 0 (B.1) Because ξi = ∂vi ∂pi pi vi is the elasticity of the violation rate with respect to the inspection rate, it is plugged into the equation above and Equation (B.1) can be simplified to the following, ξitivi − ρi ξivi pi = λe (vi + ξivi) (B.2) That is, tipi − ρi pi = λe ( 1 + 1 ξi ) (B.3) B.2 Risk-screening environmental indicators The data used to calculate ρ are from U.S. EPA’s Risk-Screening Environ- mental Indicators (RSEI Version 2.1.5). This model is a screening-level tool that assesses the potential impact of industrial releases from pounds-based, hazard-based, and risk-related perspectives. It uses risk concepts to screen large amounts of Toxics Release Inventory (TRI) data (1996-2005 TRI data). RSEI considers the following information: the amount of chemical released, the toxicity of the chemical, its fate and transport though the environment, the route and extent of human exposure, and the number of people affected. 92 B.2. Risk-screening environmental indicators Table B.1: Industries at the Four-Digit SIC Level Ranked by Average Values of the Damage Indicator over 2003’-2005’ (410 Industries) Five most damaging industries SIC Industry ρ 3312 Steel Works, Blast Furnaces (Including Coke Ovens), and Rolling Mills 3493272 2869 Industrial Organic Chemicals, NEC 2445291 3585 Air-Conditioning and Warm Air Heating Equipment and Commercial and Industrial Refrigeration Equipment 1606799 2911 Petroleum Refining 1253189 3443 Fabricated Plate Work (Boiler Shops) 955570.6 Five least damaging industries SIC Industry ρ 2448 Wood Pallets and Skids 0.108 3451 Screw Machine Products 0.107 2259 Knitting Mills, NEC 0.086 3952 Lead Pencils, Crayons, Artists’ Materials 0.044 2385 Waterproof Outerwear 0.017 Risk-related results: the toxicity, surrogate dose, and population com- ponents are multiplied to obtain a risk score for the Indicator Element. Pounds-based results: these results include only the pounds of releases reported to TRI. What should be noted is that the values are for comparative purposes and only meaningful when compared to other values produced by RSEI. Detailed information and related analyses can be found on the website: http://www.epa.gov/oppt/rsei. 93 Appendix C Appendix to Chapter 4 C.1 Background The process of environmental policy creation is the same as those of other policies. A proposal may be introduced in Congress as a bill (or joint res- olutions), which addresses the environmental issue and provides potential solutions for the problem. Each bill can be introduced by any member of Congress and has to go through several stages to come into laws. First, the bill is considered by standing committees whose jurisdictions are over this environmental issue. They investigate the details of these proposals, collect evidence and vote to decide whether the bill should be reported to the full house. Second, the full house debate and amend the bill once it is reported by the standing committees. The bill can not become law unless it is ap- proved by both houses. Lastly, a bill that passes both houses becomes a law if the president agrees to sign it.102 Given this process of policy creation, it is regarded that special interest groups could exert political pressure on congress members to influence the policy outcome. Table 1 lists some of the environmental bills and whether they failed or passed. 102If the President choses to take no action, the bill can also automatically becomes law after ten days. See details from http://en.wikipedia.org/wiki/United States Congress. 94 C .1. B ack grou n d Table C.1: Selected Vote Description Year Senate/House Bill Note 2008 S S.2191 The Climate Security Act Failed 2008 H H.R.5351 The Renewable Energy and Energy Conservation Tax Act Passed 2007 S H.R.6 A Comprehensive Energy Legislation Failed 2007 H H.R. 2643 The Interior- Environment appropriations bill Passed 2005 S H.R. 2361 The Interior Appropriations Bill Passed 2005 S S.J. Res. 20 A resolution Failed Sources: ”National Environmental Scorecard”, League of Conservation Voters 95 C.1. Background Description: Bill S.2191: To cut global warming pollution and drive rapid investment in the clean energy economy. The bill allowed major polluters to choose the most cost-efficient way to reduce pollution and buy pollution allowances to cover each ton of pollution that they continue to emit. Bill H.R.5351: To extend the tax credit for wind and other renewables by three years and reinstated expired credits for commercial and resident building. Bill H.R.6: To raise automobile fuel efficiency standards to 35 miles per gallon by 2020. To establish new energy efficiency standards for appliances and federal buildings etc. Bill H.R.2643: The Clean Air Act requires many of the largest emitters of toxic air pollutants to reduce their emissions by the maximum degree possible. The EPA proposed a rule change that would allow polluters to sidestep the requirement if they release less than 10 tons per year of a single pollutant or less than 25 tons per year of combined pollutants. This bill is to deny funds for implementing the proposed rule change. Bill H.R.2361: Chemical companies seeking pesticide approvals from EPA have submitted data from dozens of experiments in which human were intentionally dosed with these toxic chemicals. EPA have imposed a mora- torium on considering such test. This bill is to create a one-year moratorium prohibiting EPA from using any of its funds to consider or conduct research that intentionally expose humans to pesticide. Bill S.J.Res.20: Coal-burning power plants are the largest U.S. source of mercury pollution. Rather than enforce the Clean Air Act, which requires all power plants to reduce their mercury emissions by 2008, the Bush Admin- istration in March 2005 issued a rule that delays meaningful reductions for another two decades and encourages power plants to buy and sell mercury pollution credits. A bipartisan groups of Senators introduced a resolution to reject the EPA rule. 96 C.2. Data of environmental political contribution C.2 Data of environmental political contribution This appendix provides the data sources and methodology I employ in cal- culation of environmental political contribution. Part of descriptions are cited from the sources directly for accuracy. C.2.1 Members of key House/Senate environmental committee/subcommittee (1) The list of key House/Senate environmental committee/subcommittee is from League of Conservation Voters (http://www.lcv.org/president-and- congress/house and http:// www.lcv.org/president-and-congress/senate). The League of Conservation Voters is a national organization working full time to hold members of Congress accountable for their environmental votes. It pro- vides description of the jurisdiction of the key committees/subcommittees with respect to environmental issues. (2) The U.S. Government Printing Office (http://www.gpoaccess.gov /cdi- rectory/browse.html) contains the congressional directory, which is the of- ficial directory of the U.S. Congress prepared by the Joint Committee on Printing. It presents short biographies of each member of the Senate and House, listed by state or district, and additional data, such as committee memberships. Two files are used to collect the names of the members of the key environmental committees/subcommittees: “Standing Committees of the House” and “Standing Committees of the Senate”. With these two data sources, I compile a dataset containing the names of the members of the key House/Senate environmental committees/subcommittees. (“Name file”) Take data in election cycle 2003-2004 for example (data over other elec- tion cycles are similar). There are 234 candidates in the key environmental committees/subcommittees out of 3553 candidates. 97 C.2. Data of environmental political contribution C.2.2 Campaign contribution In the website of the Federal Election Commission (http://www.fec.gov/finance/ disclosure/ftpdet.shtml), there are three files that are used in this work for each election cycle. I list them below and some descriptions are cited from the website directly for accuracy: (1) The committee master file contains one record for each committee registered with the Federal Election Commission. The file contains basic information about the committees, including the ID number the Commission assigned to the committee and the name of the committee. (2) The candidate master file contains one record for each candidate who has either registered with the Federal Election Commission or appeared on a ballot list prepared by a state elections office. The file contains basic in- formation about the candidate, including name and the ID number assigned to the candidate by the FEC which is used in tracking campaign finance information about the campaign. (3) The itemized committee contributions file contains each contribution or independent expenditure made by a PAC, party committee, candidate committee, or other federal committee to a candidate during the two-year election cycle. It includes the ID number of the contributing committee and the ID number of the recipient. The committee master and candidate master files are used in conjunction with the itemized committee file to set up a relational database. They are merged according to the committee ID number and the candidate ID number respectively. C.2.3 SIC code There are various data sources used to search for the SIC code for each committee listed in the committee master file according to the name of the committee (usually a company name), e.g. COMPUSTAT, siccode.com, and websteronline.com. This data collection is difficult for the following reasons: multiple sources were used; and each committee may be assigned two or more SIC codes because of multiple production lines. However, it still 98 C.2. Data of environmental political contribution contains information that can be explored across industries. (“SIC file”) Take data in election cycle 2003-2004 for example (data over other elec- tion cycles are similar). Of the totally 1759 corporate PACS, the SIC codes are found for 1280 PACs, in which 470 PACs belong to the manufacturing group. C.2.4 Data summary In order to obtain the complete dataset, (a) I compile the “SIC file” with the committee master file and only keep the corporate committees. (b) I use the “name file” to label the candidates in the key committees/subcommittees in the candidate master file. These labelled candidates are kept for study. (c) The arranged files in (a) and (b) are merged with the itemized com- mittee contributions file. Then, this dataset contains the following infor- mation for each corporate committee: the corporate committee’ ID, its SIC code, the contribution amounts of the candidates that are in the key com- mittees/subcommittees and receive contributions from this corporate com- mittee. This is the raw dataset that can be summarized at the four-digit industry level and scaled by the industry size to calculate the environmental political contribution intensity. 99

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