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POLLUTION REGULATION AND SMALL ESTABLISHMENT FORMATIONS IN U.S. MANUFACTURING INDUSTRIES: A LONGITUDINAL ANALYSIS OF DETERRENT EFFECTS

Thomas J. Dean
Robert L. Brown
Mark De La Mater

College of Business Administration
University of Tennessee
419 Stokely Management Center
Knoxville, TN 37996-0545

Telephone
615-974-1673

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615-974-3163

Principal Topics
Theoretical arguments and empirical evidence suggest that environmental regulations deter entry into industries where the requirements for regulatory compliance activities are high. The traditionally-advanced reason is that environmental regulations increase capital spendingrequirements, thereby increasing the minimum efficient scale required for entry. Using datafrom 1977, a recent study by Dean and Brown (1994) verified an entry barrier effect that operated through increases in capital requirements However, their research also found that environmental regulations exerted a second entry-deterring effect. They argued that this additional deterrent impact was likely due to regulatory complexities and associated learning curve effects.In short, the complexities of environmental regulations appear to create difficulties for potential entrants.

Despite these important findings, the Dean and Brown study was not able to examine someimportant questions: 1) how the entry deterring effects of environmental regulations impact small businesses relative to large businesses, and 2) how have the barrier effects have changed over time. The present study extends the Dean and Brown study to address these important, but unanswered, questions.

The study focuses upon the extent to which environmental regulations deter the formation of small establishments in manufacturing industries. It is argued that environmental regulations stem the births of small establishments through resultant increases in economies of scale, business complexities, and facility siting and permitting problems. In addition, the study provides a longitudinal examination of these effects by testing for their existence over the period from 1977 to 1987. While environmental regulations have increased in scope, stringency and cumulative quantity over the period of the study, there are also a number of reasons to believe that the effects of regulations on the formation of small establishments may have diminished. The proliferation of environmental consulting and service firms, the development of small scale abatement technologies, and the ability of small establishment to outsource for their waste treatment and disposal needs may all have reduced the deterrent effects over time.

Finally, the study compares the deterrent effects of environmental regulations on small establishments to those on the formation of large establishments. Larger establishments would not be inhibited by 'increases in capital requirements resulting from environmental regulations and would likely be less encumbered by the complexities of regulations. Thus, it is hypothesized that the barrier 'impacts of environmental regulations would be less for large establishments than for small establishments.

Method
The analysis employed a mediated regression methodology on a large sample of manufacturing industries (four digit S.I.C.) for three census years (1977, 1982, and 1987). After eliminating 15 non-homogeneous industries and industries with missing information for any census year, the final sample consisted of 202 'industries. A mediated regression model of small establishment formations was estimated for each of the three periods, and compared to equivalent models for large establishment formations. 'Me mediated regression methodology allowed a determination of whether the barrier effects operated through an increase in industry economies of scale or through other mechanisms.

The research model contained four focal variables and a number of control variables. For the first set of three regressions, the dependent variable, small establishment formations, was measured as the logarithm of the number of small establishments (0-99 employees) forming in an industry in each of the three periods. For the second set of three regressions the dependent variable, large establishment formations, was measured as the logarithm of the number of large establishments (100 or more employees) forming in an industry 'in each of the three periods. Two primary independent variables were used to predict the number of new establishments. The first represented the degree to which an industry was impacted by environmental regulatory requirements and was measured as the logarithm of pollution abatement operating costs divided by total 'industry value added.

The second focal independent variable served as a proxy for industry scale economies, and was measured as the logarithm of total industry assets divided by the number of establishments in the industry. Four control variables were included in the model to partial out the potentially confounding effects of other entry inducements and deterrents They were industry excess capacity, concentration, risk, and growth.

Major Findings
Pollution abatement 'intensity exerted a remarkably consistent deterrent effect on small establishment formations over the three time periods, but the nature of the effect changed over time. hi 1977, pollution abatement intensity's deterrent effect operated exclusively through an increase in 'industry economies of scale. In both 1982 and 1987, however, economies of scale accounted for only part of the effect of environmental regulations on small establishment births. This suggests that the deterrent impact in these years is due to other mechanisms such as increased business complexity and difficulties in siting and permitting new facilities. As hypothesized, pollution abatement intensity exerted less of a deterrent impact on the formation of large establishments than on small establishments.In fact, for the large establishment formation model, the coefficient for pollution abatement intensity was insignificant in all three periods. When contrasted to the small establishment model, these findings suggest that environmental regulations deter the formation of small establishments, but not large establishments.

Implications
This study serves to validate the previous study by Dean and Brown and offers important extensions in its findings. Whereas the Dean and Brown study examined new, independent venture foundations, the present study allowed a comparison of the effects of environmental regulations on small establishments to those on large establishments. It also provided a longitudinal examination of the effects of regulations on establishment births. Foremost among the conclusions of this study is that environmental regulations appear to act as a significant deterrent to the formation of small establishments, but not to large establishments. This implies that establishment size is an 'unimportant moderating variable in estimating the impact of environmental regulations on establishment formations. The study also shows that the total impact of environmental regulations on small establishment births has persisted over the ten year period of the study. Thus, the study does not support the proposition that institutional changes have diminished the Impact of regulations on small businesses.

The differential impact of environmental regulations on small establishment formations relative to large, is of substantial interest to public policy makers. The regulatory relief granted to smaller firms in environmental regulations does not appear to have mitigated the negative impacts of environmental regulations on small businesses. Relative to their larger- scale counterparts, small establishments appear to pay a greater penalty in meeting their compliance requirements. The manner by which small firms pay the penalty, however, has changed over time. The study's findings suggest that, during the 1970s, the primary deterrent effect operated exclusively through an 'increase in scale economies. It appears that the environmental regulations of this period 'increased the fixed cost component of doing business, thereby making entry at small scale less feasible. B@ the 1980s, the deterrent effect of scale economies had diminished, but a new source of deterrence had emerged. This new source of deterrence may be due to the increased number and stringency of environmental regulations since the decade of the 1970s, and associated increases in business complexity and difficulties in siting new operations.

Beyond the implications for public policy makers noted above, this study also has important implications for corporate strategy makers and potential entrepreneurs. In 'industries having high pollution abatement requirements, small-scale entry is more difficult. This may serve to increase the rents available to large-scale manufacturers and reduce the attractiveness of the industry to entrepreneurs.

A final consideration in interpreting the results of this study is that the findings do not imply that environmental regulations should be eliminated or even reduced. A variety of benefits have accrued to environmental regulations. While this study points to one potential social cost of environmental regulations, it does not explicate the array of social costs and benefits of these regulations, and should not be used, in and of itself, to make implications regarding the net social benefit of environmental regulations.

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