Does Environmental Inspection Led by Central Government undermine Chinese heavy-polluting firms’ stock value? The buffer role of political connection

Abstract Along with the continuous and rapid growth of Chinese economy, the problem of resource shortage and environmental deterioration has been increasingly serious, resulting in considerable attention from governments and the public. To tackle the unprecedented environmental challenge, Chinese central government has adopted an increasing number of environmental regulatory instruments, such as the new Environmental Protection Law (EPL) and the environmental inspection led by central government (EICG). As the major energy consumers and environment polluters, heavy-polluting firms are always the key targets of regulations. In response, they have strong incentives to cultivate political connections to obtain laxer regulation enforcement, which may lead to the inefficient implementation of environmental regulatory instruments. The current study aims at understanding the effect of EICG, as the national-level inspection, on the stock value of heavy-polluting firms, and examining whether political connection plays a buffer role in their relationship. Using 270 Chinese listed companies in heavy-polluting industry as samples and event study methodology, the study examined the cumulative abnormal returns (CARs) under different event windows to analyze the impact of EICG on the stock value of heavy-polluting firms, and then conducted a multivariate regression analysis to test the role of political connection. The results of both t statistics and Wilcoxon signed-rank test indicated that the negative CARs during the ten-day event window are significant at the 1% level, implying that EICG has a negative impact on the stock value of heavy-polluting firms. Meanwhile, the politically connected firms suffer less wealth loss during the ten-day event window as compared to the non-politically connected ones, demonstrating that political connection can alleviate the negative effect of EICG on the stock value of heavy-polluting firms. Additionally, further analysis demonstrated that the buffer effect of political connection is stronger for state-owned firms than for nonstate-owned firms. And compared with local political connection, central political connection is more likely to mitigate the negative effect of EICG on the stock value. The findings are beneficial to environmental agencies in setting and implementing environmental regulations in more efficient ways, and provide valuable insight for heavy-polluting firms to take efforts to fulfill their environmental responsibilities.