There has been a recurring debate on whether or not environmental regulations indirectly affect a firm's cost structure by motivating it to engage in technological innovation. Accordingly, innovation would eventually play a key role in a firm's market competitiveness or profitability. The Porter hypothesis therefore presents an interesting paradigm that through regulatory impetus, firms can be motivated to pursue innovation and strengthen it's market performance. However, opponents of the Porter hypothesis argue that increasing the stringency of regulations does not necessarily equate to greater profitability.

This paper tests the Porter hypothesis by using an augmented version of Repetto's model. The empirical results show that while the sign of the correlation coefficients tend to validate those of the Porter hypothesis, the association between environmental and economic performance is either subject to a spurious correlation problem when they are significant or is insignificant even when the effects of extraneous variables are netted out.