Implementation of the New Environmental Protection Law and Capital Structure Adjustments in Heavily Polluting Firms
LIU Jianhua, CHEN Guo, ZHU Xiaoyu, LIAO Tianlong
School of Business / Research Center for Modern Accounting and Finance / Lingnan College, Sun Yat-sen University; Guangdong Technology Financial Group Co.Ltd.
Summary:
With the continuous improvement of China's environmental governance system, environmental regulations have been significantly strengthened. The implementation of the new Environmental Protection Law (EPL) in 2015, often cited as the most stringent in China's history, imposed stringent compliance requirements on firms. The new EPL focused on strengthening regulatory responsibility, increasing penalties, and enhancing public supervision. Violations could lead to severe punishments, raising environmental uncertainty for firms, and heavily polluting enterprises were expected to face greater compliance costs. This policy shift rendered the previous high-leverage, high-emission business model of heavily polluting firms unsustainable, exposing them to heightened environmental risks. We examine whether and how these firms adjust their capital structure in response to the heightened regulatory uncertainty. Employing a difference-in-differences (DID) design and data from Shanghai and Shenzhen A-share listed firms (2007-2023), we exploit the implementation of the new EPL as a quasi-natural experiment to identify its causal effect. We find that the new EPL significantly reduced the asset-liability ratio of heavily polluting firms, primarily driven by a decrease in interest-bearing debt. Compared to non-heavily polluting firms, the implementation of the new EPL had a significant negative impact on the asset-liability ratio of heavily polluting firms, which decreased by 2.4% relative to non-heavily polluting firms after the implementation. Furthermore, the reduction effect of the new EPL on the asset-liability ratio of heavily polluting firms mainly came from the decrease in the interest-bearing debt ratio. In addition, the impact of the new EPL on capital structure varies across different types of firms. The reduction effect is more pronounced among firms with lower levels of environmental information disclosure, weaker financing constraints, and those that are not major taxpayers. Mechanism tests explain how environmental regulations affect the capital structure adjustments of heavily polluting firms through changes in environmental risk. The new EPL set stricter compliance standards, increasing environmental uncertainty for heavily polluting firms. If these firms continued to use the high-leverage, extensive operational model, they would face violation penalties and high compliance costs. Consequently, firms actively engaged in environmental management to meet new emission standards and regulatory requirements, including increasing green investment and reducing production scale. These activities compressed short-term profitability, increased financial pressure, and raised operational uncertainty, thereby motivating firms to lower leverage for financial stability. First, using text analysis of annual reports, we constructed a dictionary from three dimensions, environmental and climate risk, regulatory perception, and green transition, to capture semantic features related to environmental risk, and calculated the word frequency of environmental risk keywords in annual reports based on this dictionary. The study finds that heavily polluting firms significantly increased the frequency of terms related to environmental uncertainty in their annual reports after the implementation of the new EPL, indicating that these firms conveyed an increased perception of environmental risks through textual information disclosure and had heightened psychological expectations of future environmental compliance and penalty risks. Firms that perceive increased environmental risks adopt compliant behaviors in response to stricter environmental regulations, manifested in the new EPL's effect through increased environmental investment and reduced production scale. We also explore the impact of the new EPL on trade credit. Further analysis shows that the new EPL also led to an increase in the net use of trade credit. This indicates that after the rise in environmental risk, in addition to adjusting their capital structure, firms also utilized their bargaining power in the supply chain to increase cash reserves and enhance liquidity management capabilities. Furthermore, firms reduced new bank borrowing and increased equity financing to improve their situation and maintain financial stability. Our findings contribute to the literature on the micro-level impact of environmental regulation. While prior studies focus primarily on environmental governance practices and environmental performance, we highlight how firms adjust financial structures under regulatory stringency. By examining capital structure responses to an exogenous policy shock, this study broadens the understanding of the economic and financial consequences of environmental policy. Moreover, this research contributes to the literature on risk and capital structure. Existing studies seldom examine the transmission mechanisms of environmental compliance risk. By testing how policy-induced risks are internalized into financing decisions, this study extends risk-related research into the domain of command-and-control environmental regulations, offering a novel perspective on how firms adjust risk in response to regulatory shocks, thereby enriching the theoretical foundation of environmental regulation and providing new insights for understanding and managing environmental risk in the process of green transition.
柳建华, 陈果, 朱效禹, 廖天龙. 新《环保法》实施与 重污染企业的资本结构调整[J]. 金融研究, 2025, 545(11): 77-95.
LIU Jianhua, CHEN Guo, ZHU Xiaoyu, LIAO Tianlong. Implementation of the New Environmental Protection Law and Capital Structure Adjustments in Heavily Polluting Firms. Journal of Financial Research, 2025, 545(11): 77-95.
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