Firms and environment: Exposure to pollution, search for lenient certification, and credit defaults in developing countries

The IGC co-hosted the LSE Environment Week from 19-23 September and invited researchers to present their works in progress on environment and firm challenges in developing countries. 

Firms are one of the engines of economic growth in a country. In the growth process, firms have not only just contributed to environmental degradation but also suffered from increasing environmental extremity and externalities. The impact faced and made by firms is wide-ranging from exposure to pollution, to increased cost for avoiding compliance, to growing credit default - below are summaries of some of the research presented exploring these challenges. 

Searching for customers, finding pollution: Firm location choices in African cities
Vittorio Bassi, Matthew Kahn, Nancy Lozano Garcia, Tommaso Porzio, and Jeanne Sorin

Firms in low income countries are distinctly located along the busiest roads, manufacturing in the open air. Small and short of resources to advertise their products, they aim to sell directly to the customers passing by. While this approach brings in much needed customer visibility, it exposes the workers of these small firms to pollution coming from the traffic congestion near the roads and poor infrastructure all around, directly and consistently. Vittorio Bassi, Matthew Kahn, Nancy Lozano Garcia, Tommaso Porzio, and Jeanne Sorin collect a unique dataset on firm location choices and analyse the trade-offs faced by firms in terms of profits and worker health. Their early estimates reveal that firms, by choosing to locate themselves in busy parts of town, are able to leverage their consumer visibility and make $195 more in profits annually (in comparison to a random spatial allocation) but accrue a welfare cost of a potential lowering of worker life expectancy by two months.

Firms’ willingness to pay for certification leniency: Evidence from the global wood industry
Johanna Joy Isman

Third-party certification is a means of overcoming information asymmetry in the market and signalling a certain ethical and environmental standard, such as deforestation and forest degradation. The costs of these certifications are often heavy and fall on the firms, who derive little additional benefit from them owing to the lack of their observability by consumers and investors (which might not have much consequence still). This leaves potential incentive for firms to seek certification from third-parties that are more lenient and are not as stringent about violations of environmental standards, and do not impede firms’ intention of maximising their profits. Johanna Joy Isman develops a structural model of demand and pricing of certification. Using forest management certification data and the related fees paid, she investigates variations in certifiers’ leniency and evidence for shopping for leniency. Her early estimates reveal that firms are willing to pay a significantly higher fee in return for a lenient evaluation by third-party certifiers, and thereby generate welfare losses that come from environmental externalities.

Thermal stress and financial distress: Extreme temperatures and firms’ loan defaults in Mexico
Sandra Aguilar-Gomez, Emilio Gutiterrez, David Heres, David Jaume, and Martin Tobal

Climate change has made a warmer world certain. Increasing research evidence has been revealing the adverse impact of rising temperature on economic outcomes and productivity. Credit institutions in low- and middle-income countries are already riddled by informational asymmetries and shallow credit markets, and the uncertainties consequent of the changing climate will only add to the challenges. Sandra Aguilar-Gomez, Emilio Gutiterrez, David Heres, David Jaume, and Martin Tobal investigate how extreme weather contributes to firm credit default and credit use. They utilise an extensive dataset of loans made by commercial banks to private firms in Mexico. Their findings reveal that abnormal increases in temperatures add to the rise in the rate of non-performing loans, especially in the agricultural sector which is more vulnerable to changing temperatures.

To learn more about the environmental challenges facing the world visit LSE Environment Week.