Environmental regulation, ESG, and firm value: evidence from China

Companies are facing increasing environmental regulatory risk, but the literature has rarely studied how firms respond to this type of risk. This paper uses China's Central Environmental Protection Inspection (CEPI) as an exogenous shock and explores the role of ESG engagement in mitigating the environmental regulatory risk. Our main findings are as follows. First, the CEPI reduces the market value of companies by 1.8%, or about $153,000 million. This implies that environmental regulation reduces firm value in the short run. Second, those with higher ESG scores suffer lower value degradation from the CEPI, implying that ESG plays the moderating role. Mechanism analyses suggest that ESG mitigates environmental regulatory risk by placating the government, but not by placating the public. This paper reveals a new role for ESG, i.e. buffering negative shocks from government environmental regulations. Meanwhile, our research provides helpful policy implications for governments and firms in developing countries to achieve sustainable development.