Impacts of environmental regulations, emissions trading system and climate transition risks: evidence from China

Abstract

This Ph.D. thesis consists of three empirical studies on environmental transition risks and corporate decisions and performance.

The first empirical study examines the impact of environmental regulation stringency on the location choice of pollution-intensive firms. I aim to verify the pollution haven hypothesis (Porter hypothesis) suggesting firms that would (not) choose to relocate (but to innovate) by using Chinese provincial-level data from 2008 to 2015. I proxy the regulation stringency with multidimensional institutional capacity and construct an index by using the entropy method. The stringency reduces the number and growth rate of pollution-intensive firms in highly regulated regions, especially firms in heavy industries. An important channel through which stringent environmental regulations hold back firm creation is increased financing costs. Stringent environmental regulations are not found to promote technology innovation because relocation seems less costly. I also find that raising environmental regulation stringency in one region affects pollution-intensive firms' location choice in neighbouring provinces. Overall, the results support the pollution haven hypothesis and uncover a financing-based mechanism underlying the relationship between environmental regulations and firms' location choice.

The second empirical study examines the impact of China's Emission Trading Scheme on its regulated firm's financial performance. Based on the panel data of China's ETS regulated firms from 2008 to 2017, this study uses the Propensity Score Matching Difference-in-Differences method to study how the listed firm's financial performance is affected by China's ETS. The empirical results show that firms regulated by China's ETS would escalate their financial performance in different aspects. Through the mediating effect test, this study has found that even though China's ETS would increase its regulated firm technical progress, but this progress would not affect their financial performance. These results further verify the applicability of the weak version of the Porter hypothesis but reject the strong version. Furthermore, I have tested the impact of the carbon price and its volatility on firm financial performance. Different from the traditional view on the impact of the carbon price, this study has found that growing the carbon price would benefit regulated firm financial performance, but higher volatility is harmful to the performance.

The third empirical study examines the impact of regional climate transition risk on corporate bond pricing. We find that investors would require a higher yield spread when they are buying the bond that their issuer faces higher climate transition risk. Further, we show such risks affect firms' cost of debt by increasing credit risk and incurring more financial distress. The results of the moderating effect analysis suggest that the increase in the cost of debt is more pronounced for firms in industries with high environmental litigation risk, non-state-owned enterprises (non-SOEs) and those in the region without a political turnover. Overall, our results provide evidence that the observed higher bond yield spread is the result of climate-sensitive investments practices by investors.