Stringent environmental regulation and capital structure: The effect of NEPL on deleveraging the high polluting firms

This paper studies the impact of stringent environmental regulation on the financial behavior of firms. Using panel data of Chinese listed companies from 2009 to 2018, we take the implementation of the new environmental protection law (NEPL) in 2015 as a quasi-natural experiment and identify its impact on the deleveraging of high polluting firms. The possible reason is that the nationwide legal construction by NEPL will set the tone of environmental governance for a long time in the future. Considering the environmental legitimacy and sustainable development, firms change their strategies and reduce their short-sighted behaviors, which are reflected in the changes in investment and financing. On the one hand, banks cut down loans to high polluting firms with environmental risks and increase their financing costs, thereby reducing leverage. On the other hand, firms reduce fixed asset investment and increase R&D and environmental expenditures under the formal supervision of the government and unformal supervision of other stakeholders, realizing deleveraging and green transformation. Considering the heterogeneity of firms, NEPL has a greater effect on state-owned firms, small-scale firms, technology-intensive firms, firms without political connections, high financing constraints firms, and firms in the decline stage. This study identifies the effectiveness of environmental governance on the deleveraging of high polluting firms for lowering financial risks for the first time. Our empirical evidence strongly supports that China's new environmental protection law can realize a win-win situation of the environment and economy.