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Despite the importance of environmental penalties in environmental enforcement, how and under what situations they impact stock market reaction is still unclear. Drawing on the theories of expectancy violation and attention driven, a conceptual model is built to explore how environmental penalty influences stock market reaction through investor attention. Furthermore, it is explored that the air pollution and industry saliency facilitate the indirect relationship between environmental penalty and investor attention. We empirically test this theoretical framework using a sample of 88 listed companies that received the environmental penalty. Up to 31 December 2020, a total of 88 A-share listed companies in Shanghai and Shenzhen stock exchanges were obtained as samples by collecting the announcement of environmental penalties of listed companies on Juchao Network. Furthermore Baidu index is taken as a proxy for investor attention in this study. Our findings reveal that investor attention plays mediating role in the relationship between environmental penalty and abnormal returns, while the direct effect of environmental penalty on stock market reaction has not been verified, thus, investor attention plays a complete mediating role between them. In addition, air pollution moderates the relationship between Environmental penalties and investor attention. The study found that enterprises in heavy pollution industries might suffer safety-in-numbers effect, which would weaken the directly negative impact of environmental penalties, and verified the moderating effect of industry saliency. These findings provide theoretical and practical implications for understanding how environmental penalties influence on stock market reaction.

Environmental Penalties, Investor Attention and Stock Market Reaction: Moderating Roles of Air Pollution and Industry Saliency