With technology licensing on quality innovation becoming a general phenomenon in the industry, this study
focuses on the impact of quality improvement under different environmental standards. We established a three-country
model to analyze the actions taken by the domestic firm located in the home country with high quality technology, the
foreign firm located in the foreign country with low quality technology, and the products they export to the third country.
The importing country also decides on an environmental standard for reducing environmental pollution. Our major
findings are: (1) A less strict environmental standard is preferable for the third country government in the beginning, but
the government will become stricter with the increasing substitution of products in the long term. (2) In the aspect of
licensing, the higher quality firm tends to provide an option to draw up a royalty licensing contract rather than a fixed-fee
licensing contract. (3) The social welfare of the high quality firm is always higher than that of the low quality firm, but it
will decrease with the increasing substitution of products. Coming from the increasing substitution of products, the excess
profit that is created for the low quality firm is used as a cost for pollution abatement. Therefore, the social welfare of the
foreign country does not change when the substitution of product changes. This model fully illustrates the real case of
mainland China and enriches the field of technology licensing on quality innovation.