Does air pollution impede corporate innovation?

Abstract

We examine corporate innovation and the air pollution in the city in which the firm is located. Drawing from environmental stress, resource-based, and human capital theories, we hypothesize that air pollution reduces corporate innovation because it increases a firm's financial constraints and negatively affects human capital. Our findings are consistent with our hypothesis. The findings are robust to alternative metrics of innovation and air pollution, and after accounting for endogeneity. Additional analysis suggests that when a city's air pollution is comparatively worse than other cities', a firm in the highly polluted city: 1) has tighter financial constraints, which leads it to invest less in research and development or to increase its environmental investment (crowding-out effect), and 2) attracts fewer technical, highly educated, and foreign-experienced employees (human capital effect). Our paper provides new insights into the real effects of air pollution on corporate innovation, productivity growth, and the economy.