Going Green in China: Firms’ Responses to Stricter Environmental Regulations

This paper examines the effect of stringent environmental regulations on firms' environmental practices, economic performance, and environmental innovation. Reducing COD levels by 10% relative to 2005 levels is an aim of the Chinese 11th Five-Year Plan. Using a difference-in-differences framework based on a comprehensive firm-level dataset, we find that more stringent environmental regulations faced by firms are positively associated with a greater probability of reducing COD emissions; also, there exists an evident heterogeneous effect across industries with different pollution intensities. Stricter environmental regulations also account for the sharp decline in firms' profits, capital, and labor. After executing a complete chain of tests of the underlying mechanisms, we find that firms rely more on recycling and abatement investment than on innovations when meeting environmental requirements.