Title: The effect of green innovation on corporate financial performance: does quality matter?

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Liqian Liu 1 & Amei Feng 2 & Mingxia Liu 1*

Abstract: This study provides substantial evidence of the effects of green innovation on corporate
financial performance. Using a sample of Chinese A-share listed companies in the manufacturing

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industry from 2012 to 2021, we find that green innovation significantly improves corporate financial
performance. However, this positive effect only exists in high-quality green innovation. Further, our
mechanism analysis indicates that high-quality green innovation effectively improves corporate

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financial performance through the competitiveness improvement effect.
Keywords: green innovation, high-quality green innovation, low-quality green innovation,

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financial performance

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1. School of Economic & Management, Wuhan University, Wuhan City, Hubei, China

2. School of Economics, Wuhan Textile University, Wuhan City, Hubei, China

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Email address list:

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Liqian Liu: [email protected]

Amei Feng: [email protected]

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Mingxia Liu: * [email protected]

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Acknowledgement：

This research is supported by the National Natural Science Foundation of China under the "Multi-
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market Exposure, Institutional Pressure and Corporate Green Innovation" program.

Project Grant No. 72272112

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This preprint research paper has not been peer reviewed. Electronic copy available at: https://ssrn.com/abstract=4663475
 The effect of green innovation on corporate financial performance: does quality matter?

ed
Abstract: This study provides substantial evidence of the effects of green innovation on corporate financial

performance. Using a sample of Chinese A-share listed companies in the manufacturing industry from 2012 to 2021,

we find that green innovation significantly improves corporate financial performance. However, this positive effect

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only exists in high-quality green innovation. Further, our mechanism analysis indicates that high-quality green

innovation effectively improves corporate financial performance through the competitiveness improvement effect.

Keywords: green innovation, high-quality green innovation, low-quality green innovation, financial

performance

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1. Introduction

Environmental crises such as degradation and resource scarcity have intensified in recent years, making

pollution control and sustainable resource use global challenges. With the introduction of sustainable development,
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environmental protection has become a crucial issue in the economic development process of nations worldwide

(Przychodzen and Przychodzen, 2015). Consequently, the Chinese government has implemented green innovation
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policies to encourage businesses to adopt sustainable and eco-friendly development paths.

Compared to traditional innovation, green innovation faces a double externality problem (Rennings, 2000). The

conventional view is that environmental regulations are a costly burden that governments impose on firms. Firms
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must invest in unproductive activities to reduce pollution to the environment, which reduces their profitability

(Pekovic et al., 2018). However, Porter and Vanderlinde argue that appropriately designed environmental standards
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can stimulate firms to innovate, offset compliance costs, and enhance their competitiveness (Porter and Vanderlinde,

1995). This is known as the "Porter hypothesis". Despite the relatively strong theoretical and empirical evidence on

the environmental benefits of green innovation, there is an ongoing debate about whether it can improve firms'
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financial performance, meaning whether the "Porter hypothesis" is achievable (Qing et al., 2022; Zheng and Iatridis,

2022).

According to Ghisetti and Rennings (2014), the financial benefits of green innovations for businesses vary based
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on the type of innovation. In particular, depending on the types of innovation content, green innovations were

categorized into green product innovation and green process innovation (Chen et al., 2006). Chen and Liu (2019)
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argue that the impact of green product innovation and green process innovation on enhancing a firm's financial

performance differs significantly. Recently, scholars have noted that companies may engage in "greenwashing" -

developing low-quality strategic green innovations to meet regulatory pressure and incentives - instead of high-

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 quality substantive green innovations (Hu et al., 2023; Jiang and Bai, 2022; Lian et al., 2022). Further research is

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required to determine whether there is a difference in the effects of high-quality and low-quality green innovations

on a firm's financial performance or if the "Porter hypothesis" holds for both types of green innovations.

This paper presents two main contributions. Firstly, a large portion of existing literature is based on either cross-

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sectional data obtained from questionnaires or only on the consideration of the composite dimension of "green

innovation". As a result, findings have been inconsistent. With the help of panel data and green patent information,

this paper captures that it is high-quality green innovations have a key contribution to firms' financial performance

by further examining the differences in the contributions of high-quality green innovation and low-quality green

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innovation to financial performance. Secondly, the mechanism by which green innovation affects firms' financial

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performance is unknown. A few studies suggest that environmental performance plays a mediating role in the

relationship between green innovation and financial performance (Agyabeng-Mensah et al., 2020; Cai and Li, 2018).

This can only mean that firm legitimacy (environmental performance) is a prerequisite for achieving the firm's
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efficiency outcomes (financial performance), and does not reveal the intrinsic mechanisms by which green innovation

directly affects financial performance. This paper clarifies that firm competitiveness is the more direct pathway for
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green innovation to influence financial performance than environmental performance.

This paper is structured as follows: Theoretical analysis and hypotheses development are covered in Section 2,

while Section 3 focuses on data processing and model setting. In Section 4, we present the empirical results,
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robustness tests, and the mechanism analysis of this study, followed by the study's conclusions in Section 5.

2. Theoretical analysis and hypothesis development

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It is still a matter of debate in academia whether green innovation can enhance corporate financial performance.

Most studies support the “Porter hypothesis”, which suggests that green innovation has a positive impact on corporate

financial performance (Akbar et al., 2021; Guo et al., 2019; Leyva-de la Hiz et al., 2019; Li et al., 2021; Liao, 2018;
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Ong et al., 2019; Tariq et al., 2019; Tumelero et al., 2019). However, some studies show a negative relationship

(Baah et al., 2021; Przychodzen et al., 2018), a U-shaped relationship (Deng and Li, 2020), an inverted U-shaped

relationship (Zhang et al., 2019; Zhang et al., 2020), or even no relationship (Agyabeng-Mensah et al., 2020) between
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the two.

Firms that focus on green innovation have a better chance of managing their relationships with stakeholders
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effectively. This can gain support from stakeholders and lead to an improvement in their competitiveness. As a result,

it can indirectly affect the financial performance of the firm in a positive way.

Firms can reduce costs and enhance competitiveness by implementing green innovation strategies that consider

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 stakeholders' environmental perspectives throughout their production and operational value chains. Using cleaner

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production technologies not only improves the efficiency of energy and material use per unit but also reduces resource

wastage by increasing the recycling of materials, waste, and water, thus reducing production costs (Chan et al., 2016).

By reducing the generation and emission of harmful substances, cleaner production helps firms avoid environmental

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penalties and medical bills from accidents (Agyabeng-Mensah et al., 2020). Additionally, operational costs are

considered a key factor in achieving superior financial performance (Afum et al., 2020). According to Aguilera-

Caracuel and Ortiz-de-Mandojana (2013), firms can optimize their internal processes through green innovations,

which can lead to a reduction in operational costs.

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The integration of environmental concerns into new products can increase stakeholder recognition by enhancing

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product differentiation, which in turn increases a firm's competitiveness (Miroshnychenko et al., 2017; Rezende et

al., 2019; Wang et al., 2021). Consumer perceptions play a significant role in driving green product innovation (Doran

and Ryan, 2016). With the increasing improvement of government environmental regulations and the growing
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environmental awareness of consumers, firms engaging in green product innovation can offer differentiated products,

distinguishing them from their competitors in the market. Additionally, the current rise in public environmental
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awareness presents an opportunity for firms that are the first to develop green innovations to increase their

competitiveness by enjoying a first-mover advantage (Chen et al., 2006). The demand for environmentally friendly

products by environmentally conscious consumers enables firms undertaking green innovations to reach a wider
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audience, helping them gain a competitive advantage and eventually extract a premium from it (Aguilera-Caracuel

and Ortiz-de-Mandojana, 2013). Moreover, many countries have special requirements for the environmental
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performance of the purchased goods when sourcing globally, such as the recycling and sustainability of raw materials.

Firms that engage in green innovation can enter more markets by developing green products, thus expanding their

market size, increasing their market share, and ultimately increasing their sales revenues (Ma et al., 2021). Overall,
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firms that invest in green innovation have a competitive advantage in terms of cost reduction and product

differentiation. Therefore, we propose the following hypotheses:

H1: Green innovation has a positive effect on corporate financial performance.

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Firms' profitability can differ based on the quality of their green innovations. According to Chen and Liu (2019),

green product innovation that eliminates pollutant emissions at the source is the most advanced level of green
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technology innovation. In addition, green process innovation generally encompasses cleaner production technologies

that reduce emissions during the production process and end-of-pipe solutions that treat emissions after they have

been released. The former is considered a green innovation with higher technological content, while the latter belongs

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 to a green innovation with lower technological content (Hojnik and Ruzzier, 2016). Low-quality green innovations

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may focus more on end-of-pipe technologies, such as specific filters that reduce pollution. While these technologies

can help a company comply with environmental regulations, they don't fundamentally change the production process

or improve the company's resources and capabilities (Ghisetti and Rennings, 2014). As a result, low-quality green

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innovations do not enhance a firm's profitability. High-quality green innovations may lead to cleaner production

technologies and green product innovations with green attributes throughout the value chain or life cycle. These

innovations can lead to redesigning production processes, improving energy and material use efficiency, and

generating profitability by realizing synergies between different resources and capabilities. Furthermore, products

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that contain green attributes throughout the value chain create competitive advantages by strategically capturing

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markets or establishing standards in their favor (Przychodzen and Przychodzen, 2015).

High-quality green innovation reflects a higher level of firms' commitment to addressing environmental

problems, a higher level of embedded green processes, and a more prosperous and competitive supply of green
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products or services. By investing in high-quality green innovations, firms can improve efficiency, reduce costs, and

gain a competitive advantage by meeting the needs of environmentally sensitive consumers. Therefore, we propose
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the following hypothesis:

H2: High-quality green innovation contributes more to corporate financial performance than low-quality green

innovation.
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3. Research design

3.1. Sample and data

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This study focuses on Chinese A-share listed companies in the manufacturing industry. We set the sample period

interval as 2012-2021 according to the availability of green patents and other related data. The data is obtained by

sorting and screening and consists of unbalanced panel data with 9036 valid observations. The data used in this
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research is sourced from two places: the data on corporate green innovation is from CNRDS, and the data on corporate

finance and other characteristics is from CSMAR.

3.2. Definition of variables

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3.2.1. Dependent variable

Since return on assets (ROA) is the most commonly used financial indicator (Rezende et al., 2019; Xie et al.,
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2022), we employ ROA to evaluate firms' financial performance (FP).

3.2.2. Independent variables

There are three independent variables in this paper, which are green innovation (LnGPat), high-quality green

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 innovation (LnGPat_h), and low-quality green innovation (LnGPat_l). Referring to existing related studies (Zhang

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et al., 2019), we measure green innovation (LnGPat) by the total number of green patents authorized, high-quality

green innovation (LnGPat_h) by the number of green invention patents authorized, and low-quality green innovation

(LnGPat_l) by the number of green utility model patents authorized. This paper represents all three independent

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variables by their natural logarithms. We chose to use current green patents since they were already used during the

application process and impacted the company's performance.

3.2.3. Control variables

In this paper, enterprise size (Size), operating income growth rate (Growth), gearing ratio (Lev), fixed assets

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ratio (Fixed), research and development investment (RDinput), and government environmental subsidies (LnSub)

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are chosen as control variables at the firm level. The variables are defined explicitly in Table 1:

Table 1

Definitions of all variables. er

Variable Type Name and Symbol Definition Method
Dependent Financial Performance (FP) return on assets (ROA).
variable
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Independent Green Innovation (LnGPat) the natural logarithm of the number of green
variables patents authorized (sum of invention patents and
utility model patents).
High-Quality Green Innovation the natural logarithm of the number of green
(LnGPat_h) invention patents authorized.
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Low-Quality Green Innovation the natural logarithm of the number of green

(LnGPat_l) utility model patents authorized.
Control variables Enterprise Size (Size) the natural logarithm of the total number of
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employees.
Operating Income Growth Rate (Growth) the growth rate of operating income.
Gearing Ratio (Lev) the proportion of total liabilities to total assets.
Fixed Assets Ratio (Fixed) the ratio of fixed assets to total assets.
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Research and Development Investment the proportion of current R&D investment to

(RDinput) operating revenue.
Government Environmental Subsidies the natural logarithm of the amount of
(LnSub) government environmental subsidies received
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during the year.

3.3. Model construction

In this paper, we have constructed two models to investigate the effect of green innovation on corporate financial
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performance. Model (1) examines the impact of overall green innovation, while model (2) focuses on the impacts of

high-quality and low-quality green innovations. To ensure accuracy, we use two-way fixed effects to control for

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 individual and time effects. The model is presented below:

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4. Empirical analysis

4.1. Descriptive statistics analysis

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Table 2 reports the results of the statistical analysis of the variables. Enterprises obtained an average of 11.95

green patents per year, including 3.627 green invention patents and 8.321 green utility model patents. It can be seen

that the number of high-quality green invention patents is much smaller than the number of low-quality green utility

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model patents, which indicates a structural imbalance in China's green innovation activities (Zhao et al., 2022). The

maximum values of the numbers of GPat, GPat_h, and GPat_l are 1075, 533, and 715, respectively, and the minimum

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values are 1, 0, and 0, respectively, indicating that the total green innovation, high-quality green innovation, and low-

quality green innovation vary among the enterprises. The mean value of the financial performance (FP) is 3.747, and
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the standard deviation is 6.375, which indicates that the distribution of the dependent variable is relatively uniform.

Table 2

Descriptive statistical analysis.

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Variable Obs Mean SD Min Max
FP 9036 3.747 6.375 -42.93 22.60
GPat 9036 11.95 42.35 1 1075
GPat_h 9036 3.627 19.57 0 533
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GPat_l 9036 8.321 26.89 0 715

LnGPat 9036 1.750 1.004 0.693 5.278
LnGPat_h 9036 0.664 0.908 0 4.898
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LnGPat_h 9036 1.484 1.016 0 4.745

Size 9036 8.051 1.147 5.187 10.93
Growth 9036 0.172 0.346 -0.519 3.081
Fixed 9036 22.18 13.42 1.040 68.02
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Lev 9036 43.25 18.29 3.812 92.46

RDinput 9036 4.989 3.786 0.0400 28.69
LnSub 9036 3.343 5.951 0 17.75
4.2. Baseline regression
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Table 3 consists of three columns. Column (1) serves as the reference model and contains only control variables,

column (2) reports the regression results of firms' overall green innovations on firms' financial performance, and

column (3) reports the regression results of firms' high-quality green innovations and low-quality green innovations
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on firms' financial performance.

The regression coefficient of LnGPat in Column (2) is 0.174, which is significantly positive at the 1% level,

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 indicating that an increase in the total green innovation significantly improves the firm's financial performance, and

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hence H1 is validated. This means that although enterprises developing green innovation need to invest a lot of costs

in the early stage, the financial benefits obtained from green innovation can fully compensate for these costs and

generate additional economic benefits, which supports the “Porter hypothesis”.

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In column (3), the regression coefficient of LnGPat_h is 0.273, which is significantly positive at the 1% level,

and the regression coefficient of LnGPat_l is -0.032, which is insignificant. This suggests that an increase in high-

quality green innovations rather than low-quality green innovations significantly improves the firm's financial

performance, and therefore, H2 is validated. A possible explanation for this is that low-quality green innovations

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primarily focus on reducing pollution emissions at the end of the pipeline, which has a minimal effect on improving

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energy and material efficiency and increasing sales. Conversely, high-quality green innovations predominantly focus

on cleaner production processes and greening product attributes, which substantially impact energy and material

efficiency and the differentiation of green products. As a result, high-quality green innovations lead to lower
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production costs and higher sales revenues, ultimately resulting in increased ROA.

Table 3
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Baseline regression.
(1) (2) (3)
FP FP FP
LnGPat 0.174***
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(0.062)
LnGPat_h 0.273***
(0.069)
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LnGPat_l -0.032
(0.067)
Size 1.610*** 1.551*** 1.541***
(0.065) (0.070) (0.070)
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Growth 4.615*** 4.610*** 4.613***

(0.239) (0.238) (0.238)
Fixed -0.060*** -0.059*** -0.058***
(0.005) (0.005) (0.005)
Lev -0.173*** -0.174*** -0.173***
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(0.005) (0.005) (0.005)

RDinput -0.208*** -0.211*** -0.216***
(0.021) (0.021) (0.021)
LnSub 0.006 0.007 0.007
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(0.010) (0.010) (0.010)

_cons 0.187 0.490 0.563
1.610*** (0.625) (0.630)

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 Individual/Year yes yes Yes
N 9036 9036 9036

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Adj-R2 0.300 0.300 0.301
Note: t-values are in parentheses. * indicates p < 0.1 ** indicates p < 0.05, *** indicates p < 0.01. The table that follows is consistent with this meaning.

4.3. Robustness test

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4.3.1. Replacement of core indicator measures

To ensure the reliability of the findings, we draw on existing research by replacing the dependent variables from

ROA to ROE (Lin et al., 2019) and re-testing. The results are shown in Table 4, Columns (1)-Column (2). We find

that using a proxy indicator to measure financial performance (FP1) does not affect the previous results.

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4.3.2. Adding control variables

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To eliminate the effect of the previous period's performance on the current period, we add the previous period's

financial performance (ROA t-1) as a control variable, and the results are shown in Table 4 Columns (3)-Column (4).

The re-testing results by controlling the previous period's ROA are generally consistent with the previous results,

proving that the conclusions of this paper are robust.

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Table 4
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Robustness check.
(1) (2) (3) (4)
FP1 FP1 FP FP
LnGPat 0.632*** 0.146**
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(0.157) (0.067)
LnGPat_h 0.755*** 0.159**
(0.172) (0.074)
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LnGPat_l 0.171 0.021

(0.163) (0.074)
ROA t-1 0.440*** 0.440***
(0.028) (0.028)
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Size 3.226*** 3.177*** 1.011*** 1.005***

(0.173) (0.172) (0.084) (0.085)
Growth 10.401*** 10.409*** 4.804*** 4.806***
(0.556) (0.556) (0.280) (0.280)
Fixed -0.115*** -0.113*** -0.029*** -0.028***
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(0.013) (0.013) (0.006) (0.006)

Lev -0.292*** -0.291*** -0.116*** -0.115***
(0.016) (0.016) (0.007) (0.007)
RDinput -0.471*** -0.483*** -0.168*** -0.172***
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(0.050) (0.051) (0.024) (0.025)

LnSub 0.027 0.029 0.023** 0.023**
(0.025) (0.025) (0.011) (0.011)

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 _cons -5.735*** -5.333*** -1.250* -1.197
(1.430) (1.442) (0.757) (0.766)

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Individual/Year yes Yes yes yes
N 9025 9025 6054 6054
Adj-R2 0.210 0.211 0.413 0.413
4.3.3. PSM test

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To avoid potential sample selectivity bias and endogeneity problems associated with omitted variables, we use

the neighbor propensity score matching (PSM) method to calculate the propensity score values, retain the samples

that satisfy the common support assumptions, and then re-test the models (1)-(2). The fitting results before and after

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when Gpat is treated variables are shown in Fig. 1, and the re-test results are shown in Table 5. It can be seen that the

sign and significance of the coefficients of each explanatory variable remain unchanged after re-testing, indicating

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that the findings of this paper remain robust after controlling for possible endogeneity issues.

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Fig. 1. Fitted P-score before and after matching.

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Table 5

PSM test.
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(1) (2)
FP FP
LnGPat 0.175***
(2.672)
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LnGPat_h 0.279***
(3.641)
LnGPat_l -0.035
(-0.516)
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Size 1.547*** 1.537***

(24.373) (24.015)
Growth 4.613*** 4.616***

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 (27.614) (27.640)
Fixed -0.059*** -0.058***

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(-12.203) (-12.053)
Lev -0.174*** -0.174***
(-47.006) (-46.794)
RDinput -0.212*** -0.217***

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(-12.357) (-12.585)
LnSub 0.006 0.007
(0.603) (0.648)
_cons 0.548 0.619
(0.848) (0.951)

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Individual/Year yes yes
N 4457 4457

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Adj-R2 0.301 0.301
4.4. Mechanism analysis

It is clear from the previous analyses that green innovation can improve financial performance through
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competitiveness-enhancement effects. This mainly includes reducing production costs by improving the efficiency

of energy and material use through cleaner production, as well as improving the revenues of green products through

product differentiation. Based on this, the mediation effect model of (3)-(6) is applied to test the mechanism of green
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innovation on the financial enhancement effect:
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We use competitive ability (CA) to capture firms' competitiveness-enhancing effect. Referring to Su Yuan and
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Li Guangpei (2021), we measure competitive ability (CA) by using the asset contribution ratio used to describe a

firm's business performance and competitiveness level, which is specified as the sum of the firm's total profit, total
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tax, and interest expense for the year then divided by the total assets.

Table 6 reports the regression results of model (3) - model (6). Column (1) confirms that high-quality green

innovation generates a competitiveness-enhancing effect. Based on this, column (3) further validates the specific
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effect mechanism and confirms that the competitiveness-enhancing effect of high-quality green innovations has a

partial mediating effect on the improvement of firms' financial performance. At the same time, it can be seen that

low-quality green innovations cannot improve the firm's competitiveness. As can be seen from columns (2) and (4),
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on the whole, firms can effectively improve their financial performance by enhancing their competitiveness through

high-quality green innovations.

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 Table 6

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Mechanism analysis.
(1) (2) (3) (4)
CA CA FP FP
LnGPat 0.187** 0.032**

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(0.085) (0.016)
LnGPat_h 0.378*** 0.048***
(0.092) (0.016)
LnGPat_l -0.114 0.005
(0.092) (0.017)

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CA 0.848*** 0.848***
(0.007) (0.007)

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Size 1.725*** 1.753*** 0.015 0.021
(0.104) (0.103) (0.020) (0.019)
Growth 4.345*** 4.338*** 0.119** 0.117**
(0.302) (0.302) (0.059) (0.059)
Fixed -0.076*** -0.077*** 0.010*** 0.010***
(0.007)
er (0.007) (0.001) (0.001)
Lev -0.189*** -0.190*** -0.006*** -0.006***
(0.007) (0.007) (0.001) (0.001)
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RDinput -0.304*** -0.296*** 0.032*** 0.033***
(0.034) (0.033) (0.006) (0.006)
LnSub 0.010 0.010 0.003 0.002
(0.012) (0.012) (0.002) (0.002)
_cons 2.603*** 2.394*** -1.363*** -1.410***
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(0.927) (0.918) (0.191) (0.189)

Individual/Yea yes yes yes yes
N 5689 5689 5689 5689
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Adj-R2 0.313 0.312 0.969 0.969

5. Conclusion

This study examines the impact and the mechanism of green innovation on corporate financial performance
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based on the green patent data of Chinese A-share listed companies in the manufacturing industry from 2012 to 2021.

We found that on the whole, green innovation can significantly improve financial performance. Further analysis

shows that only high-quality green innovations can generate this effect. Our mechanism analysis reveals that high-
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quality green innovation can effectively improve financial performance through competitiveness-enhancing effects.

The findings of this paper suggest that developing high-quality green innovation is a viable strategy for firms to
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achieve higher financial performance.

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 ed
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