Does Learning from Inspections Affect Environmental Performance? Evidence from Unconventional Well Development in Pennsylvania

With the growing concern for the environment, manufacturing facilities across the world have come under increased regulatory scrutiny. For instance, in the United States, the Environmental Protection Agency (EPA) monitors compliance for 44 programs authorized by statutes, such as the Clean Water Act, Clean Air Act, Toxic Substances Control Act, and so forth. These programs often use facility inspections to confirm compliance with environmental regulation. To illustrate, the EPA conducted over 187,000 facility inspections, from 2009 to 2014, just toward ensuring compliance with the Clean Water Act.

One reason why facility inspections are extensively used in compliance monitoring programs is that they allow inspectors to visit manufacturing units, collect information, and review processes. As a result, inspections allow regulators to determine whether operations comply with or violate environmental regulations. When operations are noncompliant, regulators can issue sanctions to move facilities toward compliance or initiate actions to suspend operations. These aspects of inspections have been recognized and a large body of work has explored the role of environmental inspections in detecting violations.

However, what is not so obvious is that environmental inspections can also enable organizations to develop knowledge (i.e., learn), which allows them to adopt practices aligned with environmental regulation. This is because when inspectors visit facilities they can highlight potential pitfalls in operations, present details of solutions to problems, and provide information on best practices. Moreover, firms can observe what inspectors are checking and see the processes that are being scrutinized. These aspects of inspections can help firms improve their understanding of the regulatory requirements and enable them to better comply with environmental regulation. However, not much research has explored how environmental inspections can facilitate organizational learning. Consequently, in this study (i.e., Mani and Muthulingam 2019), we seek to examine how experience with environmental inspections can enable firms to develop organizational knowledge and improve their environmental performance? Additionally, we decompose the inspection experience based on inspection outcomes into experience with “success” (i.e., inspections which find that operations are compliant with the regulations) and “failure” (i.e., inspections which find that operations are in violation of the regulations). This allows us to examine how firms can learn from inspection experience with success and failure.

To explore our research questions, we examine the development of unconventional oil and gas wells in Pennsylvania. Since 2004, the state has witnessed a boom in the development of unconventional wells, which use new production techniques (i.e., horizontal drilling coupled with high-volume hydraulic fracturing, more commonly known as fracking) to capture natural gas embedded within underground shale formations. From 2004 to 2014, 122 operators developed 13,606 unconventional wells across 40 counties in Pennsylvania. To monitor the rapid growth in gas extraction, the Pennsylvania Department of Environmental Protection Office of Oil and Gas Management (DEP) instituted a comprehensive environmental inspection program to ensure compliance with the environmental regulation (as outlined in Pennsylvania’s Oil and Gas Act). In this period, 160 DEP inspectors conducted 55,278 environmental inspections at the unconventional wells, of which 2,743 detected violations and in 491 of these instances also levied monetary penalties. We obtained detailed data on the inspections, the development of unconventional wells, and the production of oil and gas. Additionally, we interacted with several key DEP members and unconventional well operators to better understand the regulatory perspective and the industry responses. Thus, we obtained a comprehensive view of the industry that adopted a new technology in a stringent regulatory setting, which allows us to understand how inspections can facilitate the development of organizational knowledge.

Our results show that a focal unit (i.e., a focal unconventional well) learns from the experience with failure gained at other units within the organization. One standard deviation increase in experience with failure at the organization can lower the probability of violations at the focal unit by over 23%. By contrast, a focal unit does not learn from the experience with success gained at other units within the organization. Additionally, we find that a focal unit learns from the experience with failure gained at other units outside the organization but within a proximate geographical area such as a county. A standard deviation increase in experience with failure in a county can lower the probability of violations at the focal unit by over 25%. Thus, our results contribute to the inspection literature by illustrating the role of inspections in the development of organizational knowledge. Furthermore, we find that penalties have a divergent effect on the impact of experience with failure. In the presence of penalties, a focal unit learns from the experience with failure when it is gained at other units within the organization. One standard deviation increase in experience with inspections that levy penalties for an organization can reduce the probability of violations at the focal unit by over 16%. But such learning effects are not observed at focal units when other units within a county gain experience with inspections that levy penalties. These results contrast with the environmental literature, which finds that the impact of penalties spills over and induces improved performance at other organizations.

Our results raise the following natural question: Why do failures lead to learning more so than successes in the context of inspections? Although success provides evidence of what works it may also simplify managerial decisions and managers could become less receptive to improvement suggestions from other sources, such as environmental inspectors, vendors, or industry peers. As a result, a focal unit may be unable to leverage inspection experience with success. Conversely, when other units experience failure, it could prompt focal units to reevaluate their processes and routines as well as seek solutions to ensure operations conform with environmental regulations. Consequently, experience with failure can initiate a deeper inquiry into the underlying practices and facilitate learning.

Overall, our results provide pointers on how to improve environmental performance. Firms that face violations could focus their efforts on understanding what other organizations did to address the environmental issues. Further, firms within a region could create a common platform for sharing and exchanging ideas on how to avoid environmental issues. Regulators could focus on making information on environmental violations along with the solutions more transparent to facilitate the learning process. For instance, although the DEP provides information on environmental violations through a public website, it could augment the website to provide details of the solutions that were used to address specific environmental issues. Additionally, to leverage the inspection experience with success, the firms and the DEP could consider identifying good operational practices and sharing this information so that the industry can better comply with environmental regulations.

Reference

Mani V, Muthulingam S (2019) Does learning from inspections affect environmental performance? Evidence from unconventional well development in Pennsylvania. Manufacturing  Service Operations Management 21(1):177–197.

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