Operating risk of enterprises when adopting environmental regulation: Evidence from environmental protection law in China

Abstract

Addressing the negative externality of pollutant emissions requires environmental regulations. The well-designed environmental regulation can stimulate innovation and reinforce management, which may lead to operating risk decreases in heavily polluting firms. This study evaluates the effect of environmental regulations using the enactment of the Chinese New Environmental Protection Law (NEPL) in 2015 as an exogenous shock. Our difference-in-differences estimation shows that the deterrent of the NEPL reduces the operating risk of heavily polluting firms, and the relationships are robust to different specifications and alternative settings. We also find that the impact of the NEPL is more pronounced in subsamples with higher ex-ante innovation and improved environmental management. Further evidence shows that innovative firms may be better positioned to develop green technologies by patenting to comply with environmental regulations. Moreover, the improved environmental management practices under regulations may attract more analyst attention which help firms build a positive reputation in the market. Such responses to comply with environmental regulations ultimately reduce the operating risk of firms. Overall, our study sheds light on the micro mechanisms behind the NEPL's effect on firms' operating risk, providing implications and references for policymakers and firm managers.