Can strict environmental regulation reduce firm cost stickiness? Evidence from the new environmental protection law in China

Abstract

The existing literature presents considerable controversy regarding the impact of environmental regulations on enterprise competition. This paper adds to the literature with new evidence from the perspective of cost stickiness. External environmental regulations can create operational pressures for enterprises, leading to changes in cost adjustment. We utilize a difference-in-differences method to examine the impact of environmental regulations on firm cost stickiness, focusing specifically on the quasi-natural experiment of implementing China's new environmental protection law in 2015. Findings indicate that the implementation of this law exerts a substantial effect on reducing firm cost stickiness. Mechanism tests reveal that this reduction is primarily achieved through lowering adjustment costs, managing executive expectations, and addressing agency problems. Heterogeneity analysis shows these effects are pronounced in enterprises with strict financial constraints and CEO non-duality. By expanding upon existing literature concerning factors influencing cost stickiness and providing valuable empirical evidence supporting strengthened environmental regulation, this paper contributes to enhancing our understanding of the economic consequence of environmental governance.