Time to say goodbye? The impact of environmental regulation on foreign divestment

We look at divestments by foreign firms—a topic that has received comparatively little attention in the literature—and investigate how changes in the regulatory environment in the host country may impact on such divestment decisions. We use the implementation of China's two control zones (TCZ) policy as a “quasi-natural experiment,” using detailed firm-level combined with city-level data for the empirical analysis. Our results show that the implementation of the TCZ policy has led to higher probabilities of divestments by foreign firms in cities and industries targeted by the TCZ policy. The mechanism behind this seems to be a TCZ-induced increase in discharge fees and efforts to reduce SO₂ emissions. Allowing for heterogeneity of effects, we find that the effect is particularly strong for firms from source countries with less stringent environmental regulation and those using less advanced technology. We also show that firms using intermediates from polluting industries also experience a higher probability of divestment.