The Effects of Environmental Performance on Firm Behavior: The China Experience

This thesis examines how environmental performance influences corporate financial behavior and capital market outcomes in China. Through three empirical studies spanning 2012 to 2023, it sheds light on the pricing of environmental risk and the institutional channels through which sustainability concerns influence firms’ financial behavior. Each chapter leverages unique regulatory shocks or environmental disclosures to explore different dimensions of this relationship.

Chapter 1 evaluates the effect of the NEPL on firms’ cost of equity capital using firm-level data from 2012 to 2020. Employing a Difference-in-Differences (DID) framework, we find that following the implementation of China’s New Environmental Protection Law (NEPL) in 2015, firms in pollution-intensive industries experienced a substantial increase in equity financing costs. This increase is more pronounced for firms under greater government scrutiny and market oversight. Two primary mechanisms, strengthened enforcement and increased public disclosure, explain how institutional reforms elevated the salience of environmental risk in investors’ pricing decisions. Further evidence shows that green investors actively divest from high-risk firms, reinforcing the pricing of sustainability under credible regulation.

Chapter 2 investigates the relationship between environmental performance and corporate cash holdings. Using firm-level panel data from 2012 to 2021, we find that firms with stronger environmental performance tend to hold less cash, consistent with the precautionary motive for liquidity. This effect is driven by lower environmental litigation risk and reduced financing frictions. Causal identification is achieved through a DID design around the 2015 enactment of NEPL. The negative effect is stronger in regions with stricter enforcement and among firms held by environmentally focused institutional investors. These findings highlight the role of environmental performance in mitigating uncertainty and shaping liquidity management.

Chapter 3 explores how institutional investors respond to formal environmental risk labeling. Using a staggered DID approach on panel data from 2015 to 2023, we examine investor behavior around firms’ inclusion in the Ministry of Ecology and Environment’s Key Monitored Polluters (KMP) list. We find that institutional investors significantly reduce their holdings in designated firms, particularly where local enforcement is strong and market visibility is high. This reallocation is driven by concerns over litigation exposure and reputational damage. Additional analysis shows that firms suffer declines in valuation and operational performance following KMP designation. These results underscore the influence of regulatory signals on capital reallocation and asset pricing in emerging markets.

Collectively, these three studies provide a comprehensive perspective on corporate behaviour under China’s evolving environmental governance. The evidence suggests that environmental regulation operates not as a simple cost shock, but as a multifaceted process shaped by disclosure strategies, internal risk management, and external investor discipline. These findings contribute to a deeper understanding of how sustainability concerns are transmitted into financial markets and corporate policies, offering important implications for policymakers, managers, and investors.