Environmental violations and financial distress risk: Evidence from Chinese listed heavily polluting companies

• Published in: Pacific-Basin finance journal 2025-02, Vol.89, p.102583, Article 102583
• Main Authors: Xing, Kai, Yang, Fang, Liu, Ping, Wang, Jue, Wu, Junchuan
• Format: Article
• Language: English
• Subjects: Agency theory; Environmental violations; Financial distress risk; New environmental protection law
• ISSN: 0927-538X
• DOI: 10.1016/j.pacfin.2024.102583

This study uses data from Chinese A-share listed companies in heavily polluting industries from 2012 to 2021 to investigate the influence of environmental violations on the risk of financial distress. Empirical results show that if a company is involved in environmental violations, the probability of experiencing financial distress increases. This finding is validated through a series of robustness tests. Mechanism analysis reveals that environmental violations exacerbate financial distress through two channels: increased financing constraints and decreased internal control quality. Heterogeneity analysis indicates that the aggravating effect of environmental violations on financial distress is stronger in firms with high levels of information asymmetry and low female representation on the board of directors. Further analysis finds that the new Environmental Protection Law has a negative moderating effect on the relationship between environmental violations and financial distress. These findings provide important insights into how corporate governance and legislation can protect the environment and achieve sustainable development. •We find if a firm is involved in environmental violations, the probability of experiencing financial distress increases.•This effect is mainly due to an increase and a decrease in two aspects—financing constraints and internal control.•Further, we discover that the new Environmental Protection Law can reduce environmental violations.•These findings provide important implications for how to protect the environment via corporate governance and legislation.