Going Green: The Effect of Environmental Regulations on Firms

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2022
Authors
Fan, Grace
Wu, Xi
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We study the effect of environmental regulations on corporate innovation and valuation, accounting for all effective rules from the Environmental Protection Agency (EPA). Using a difference-in-differences approach based on large variations of EPA regulations at the industry level, we find that stricter EPA regulations are associated with a reduction in pollution, suggesting direct environmental benefits. Firms that experience large increases in EPA regulations have an increase in the number of patents, especially “green” patents, relative to firms that do not. At the same time, stricter EPA regulations, especially innovation-related ones, are associated with an improvement in firm valuation. Moreover, the positive valuation effect is more pronounced for firms with managerial myopia and weak corporate governance. Our results suggest that proper environmental regulations can serve as external governance mechanisms, and benefit firms by overcoming inefficiencies in internal governance, thereby promoting innovation and enhancing valuation.
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Corporate Governance, Environmental Regulation, EPA, Innovation, Firm Valuation
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