How does environmental regulation affect productivity? The role of corporate compliance strategies

Existing research is mixed on whether environmental regulations improve productivity, yet few studies clarify the debate from the lens of corporate compliance strategies. We establish a partial-equilibrium model incorporating the choice of optimal compliance strategy and theoretically illustrate the relationship between environmental regulation and TFP. Taking China's most stringent New Environmental Protection Law (NEPL) as a quasi-experiment, we utilize Chinese-listed company data from 2010 to 2020 to verify their relationship. The results demonstrate that the NEPL enhances productivity at firm and industry levels, but the productivity-enhancing effect decays over time. Firms' compliance strategies of innovation, exit, and relocation are three mechanisms, of which innovation plays the most prominent role. Strategic choices are affected by human capital; firms with high human capital tend to innovate, while others choose to relocate or exit. Our findings highlight the importance of compliance strategies in impacting productivity and provide implications for regulators to design sustainable regulatory tools.