Supplemental environmental projects (SEPs) provide one means of addressing environmental violations in alignment with the Biden Administration’s comprehensive environmental justice (EJ) strategy. SEPs were explicitly endorsed by Attorney General Merrick Garland as a tool for incorporating EJ considerations into the environmental enforcement process. The relationship between the EJ strategy and reinstatement of SEPs has previously been discussed in this forum in several informative posts by McHugh et al. (2022), Auslander et al. (2022), and Dean et al. (2022).[1]

Followers of these important trends might be intrigued by findings in a recent article in a journal published by the American Economic Association that takes a quantitative look at SEPs.[2] In a SEP, the payment of a penalty that has been imposed for breaking an environmental law is made in-kind via a project that does good things for the environment, rather than in money to the U.S. Treasury. SEPs can be proposed by defendants in such cases, and there are guidelines as to what makes a good SEP and when they can be accepted. At most, 80% of the assessed penalty can be allocated to a SEP, so some cash is always involved.

The article addresses several basic questions about SEPs. How does the public feel about SEPs versus monetary payments? How do financial markets view penalties, and is the SEPs route good for businesses’ bottom lines? Do SEPs noticeably improve environmental quality? And, because addressing EJ is one goal of SEPs, is that goal being achieved in practice?

The analyses the authors undertake and the conclusions they reach likely will be interesting to participants in environmental enforcement cases. At least some such participants may not regularly peruse publications in academic economics journals. If you are one of those, this post is for you.

Public Perceptions

The paper reports the results of economic choice experiments undertaken by the authors. Members of the public (2,361 individuals) were given several scenarios in which penalties of various sizes could be paid in various ways, and respondents were asked which they preferred. This is somewhat like showing people a selection of cars they could buy with various combinations of features (with and without a moonroof, leather seating or not, different 0-60 times, levels of fuel economy, price, and so on) and asking—which would you buy if you were in the market for a new car? Of course, people think about buying cars all the time but not routinely (if ever) about alternative ways of paying environmental penalties. But the athors’ approach can be informative even if the exact results should be taken with a hefty dose of salt. And the authors do a good job of investigating how such questions should be asked when traveling this methodological route.

The paper finds that the public at large prefers SEPs to dollar payments. When asking if a $300k cash settlement was better or worse than having $100k spent on a SEP, fully 81% of respondents favored SEPs. And when the SEP is in an EJ community that goes up to 87%. Favoritism toward SEPs increases as the dollar cost of the SEP increases, exceeding 90% as the hypothetical spend on SEPs matches the $300k, but falls slightly as the SEP gets to $400k compared to a $300k case settlement. It seems that the respondents see the $300k as “fair” and getting too big unjustly punishes the defendant, even when a SEP is located in an EJ community.

A second finding related to public opinion is that individuals view a firm more favorably, in both reputational and financial terms, if it pays its penalty via a SEP than if it pays in cash. This begs the question of whether that favorable view translates into a concrete financial benefit to firms, to which we now turn.

Benefits to Business

The authors examine stock exchange data to see how a firm’s share price reacts to a settlement. This paper finds that, on average, settlements do not affect stock prices. This contradicts earlier research findings that after a settlements are published in the news it depresses a firm’s share price. Reasoning that the news does not pay much attention to small settlements, the current authors looked more closely at large settlements, limiting the data to settlements greater than the median, 75th percentile, and 90th percentile of their settlement range. The findings did not change when looking at settlement sizes above the median or 75th percentile, but they did, and dramatically, above the 90th. For the biggest settlements (north of $175 million), a cash settlement led to a statistically significant 0.45% drop in share price the day after the settlement was announced. It seems that the market took note of the financial hit to the company, and perhaps also that the company would increase its future pollution control costs. However, if the penalty was paid as a SEP, the share price rose a statistically significant 0.7%. That 1.15% share price difference is a wow moment. Why this difference? The data on stock prices alone can’t answer this, but the positive reputational effect is meaningful. Maybe it signals to the market that because the firm demonstrated cooperation and a willingness to invest in community benefits, the future regulatory pressure will be altered in some way, or maybe the SEPs involved capital improvements that the market thinks will enhance firm performance down the road. But at this point, these possible explanations are just untested hypotheses for future research.

One clear lesson here for companies comes from comparing the current findings to the past ones. If you want a reputational bump from undertaking a SEP, make sure it gets published in the news—both local and financial.

Benefits to the Environment

The authors next examine whether the environment actually improves in areas where penalties are enforced. This could of course go either way—maybe a penalty achieves its goal of increasing incentives for being careful about future emissions, or maybe the cost of a penalty crowds out other investments, such as pollution control equipment. Air quality indicators at the zip code level are used in the authors’ analysis.

The authors find that for settlements of any size, a cash settlement leads to improved air quality in the region around the site involved. This is at least some evidence against the “cash settlements crowd out pollution control expenditures” hypothesis noted above. For SEP settlements, there was some improvement but not a statistically significant one.

This is weak evidence as the authors note that an assumption undergirding their analysis (that allows one to draw causal conclusions and not just correlations) did not hold for all the data. When looking only at the settlements above the 90th percentile, however, this key assumption does hold. For these data, a cash settlement leads to an improvement in air quality, but only in the short run, and SEPs do not have any clear impact on environmental quality at all. This is perhaps partly due to a measurement issue and is dependent on the nature of the SEP. For example, suppose the SEP provides grant funding to install indoor air filters. That won’t impact the measured outdoor air quality but may greatly impact the lives of those who receive the air filters. The geographic scale of the environmental data may also contribute to a limited ability to discern the effect of either type of settlement.

Exploring these types of nuances in the data certainly seems a good area for further research.

Benefits to Underserved Communities

Because one of the stated goals of SEPs is to provide benefits to EJ communities, the authors investigated whether this actually happens. Their analysis is imperfect, but intriguing.

The definition of an EJ community has evolved, as EPA’s EJ screening tool has been developed and refined, and other tools are developed by state and federal agencies. To use the EPA approach would have severely limited the data, so the authors instead use a simple demographic index that is the average of the percent of the community with low income and the percent of the community that is non-white. Obviously, this is index is not comprehensive; yet it does tell us something. Using the national distribution across communities, the authors plot the fraction of settlements occurring as SEPs versus the demographic index.

What the authors find is remarkable: a clear, quite-smooth U-shape that indicates SEPs are more common at the ends of the demographic distribution. About 6.5% of settlements are via SEPs at a demographic index corresponding to the richest and whitest communities, and about 5.5% are SEPs at the 10th decile (highest minority/lowest income communities). It bottoms out in the range in the middle of the distribution with 3%–5% of settlements being in-kind.

On its own, this is a quite interesting finding. If we add a hypothesis that historical levels of enforcement were lower in EJ communities when these data were generated, it seems likely that the share of total cases with SEPs would be lower in EJ communities than in the most advantaged. Presumably, the current emphasis will alter this apparent imbalance.

There is still work to do on that front, both in terms of research and in the design of the SEP program to enable EJ communities to take advantage of these opportunities.

Summary

These are interesting findings for environmental professionals. They provide evidence that SEPs generate value to the public at large, to the businesses who propose them, and can result in benefits to the environment if designed properly. Independent of the applications to SEPs, they demonstrate that the public values actions that seek to provide benefits beyond simple compliance with penalties. These findings also highlight the need to develop tools that can quantify the health and environmental benefits that arise from SEP interventions. Some of these may not be easily measured via existing EJ screening tools or even the baseline environmental monitoring data that they depend upon. And perhaps most importantly, these findings highlight the need for ongoing efforts to ensure that EJ communities have the capacity to participate in the development and selection of SEPs, and influence where they occur.