The paper analyses the relationship between environmental regulation and environmental innovation with insights from the diffusion of innovations theory. We base the analysis on three theoretical approaches: neoclassical, evolutionary and induced innovation. The relationship is tested using a German firm-based panel and a count data model. We estimate the propensity of firms to innovate in response to five initiating factors, namely the fulfilment of existing legal requirements, expectations towards future legal requirements, financial incentives, demand for environmental innovations and self-commitment. We also check for the relevance of the interactions between policy instruments as well as the influence of internal factors and path dependency. In addition, we control for R&D intensity, the region, the sector of the company and filter for companies that account for their environmental impact. The results answer the central question concerning the design of environmental policies in order to foster innovation. Comparing a static model to a dynamic one, we show that only long term objectives policies and market incentives are positively associated with environmental innovation. Conventional regulatory tools, namely legally binding instruments, are not effective for triggering innovative behaviour at the rm level. Lastly, we show that the threat of future environmental regulation is a necessary condition for self-regulation.
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