Abstract In this article, we develop and implement a methodology for analyzing the sources of variation in environmental efficiency across producers. We formulate a two‐stage model. In the first stage, we use stochastic frontier analysis to estimate both technical and environmental efficiency. In the second stage, we again use stochastic frontier analysis to regress estimated environmental efficiency scores against a variety of technology, physical environment, and management variables. In this stage we estimate the impact of each explanatory variable on environmental efficiency, and we derive conditional estimates of environmental efficiency from the one‐sided error component. We illustrate our methodology with an empirical application to a panel of Dutch dairy farms. We find evidence of relatively low levels of environmental efficiency, and we find that environmental efficiency can be improved through a number of policy options, including the provision of farmers with more insight into the nutrient balance of their farms.
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