Strategic Reaction to Environmental Regulation: The Combined Effect on Earnings Management and Environmental Information Disclosure

ABSTRACT We investigate firms' strategic reactions to environmental regulation enforcing China's New Environmental Protection Law (NEPL). We find that in the short term, polluting firms conduct more earnings management and the effect is stronger for firms under performance pressure. In the long term, environmental regulation facilitates environmental information disclosure, which is strengthened by better external governance. We also find that NEPL enforcement has an immediate negative effect on firm value but decreases firms' long‐horizon price crash risk. Our study highlights the combined effects of environmental regulation on firm decisions and outcomes in different horizons.