Directional distance functions and environmental regulation

In this paper we use directional technology distance functions to evaluate the impact of environmental regulations on firms' performance. Following Färe et al. [Färe, R., Grosskopf, S., Lovell, C.A.K., Pasurka, C., 1989. Multilateral productivity comparisons when some outputs are undesirable: a nonparametric approach. The Review of Economics and Statistics 71, 90-98.], we construct an index that measures opportunity costs for individual firms arising from regulations that prevent free disposal of wastes. The methodology is applied to a sample of Spanish producers of ceramic pavements. We assume that firms maximise desirable output simultaneously reducing inputs, with no change in the production of bad outputs. Our results show that when firms face environmental rules preventing free disposal of bads, their potential to increase desirable output by behaving efficiently is largely affected. We also find that large firms show smaller regulation costs.