Regulation-induced financial constraints, carbon emission and corporate innovation: Evidence from China

Prior literature documents that in developed economies, tighter environmental standards may induce higher firm innovations. In contrast, using China's firm-level CO2 emissions data, this paper finds that firms with higher CO2 emissions are associated with lower corporate innovation. A 1% increase in carbon emissions reduces research and development (R&D) expenditures by about 4.3% to 6.3%, having controlled for endogeneity concerns. While technical and commercial uncertainty of innovation can deter high carbon-emitting firms from investing in R&D, we find that high carbon-emitting firms are financially constrained when faced with exorbitant pollution-related expenses. Instead, such firms acquire firms with green assets and purchase low-polluting target assets to mitigate environmental pollution. The results are more pronounced in firms with poor corporate governance, resource-constrained non-SOEs, and highly polluting firms. Our results remain robust for different measures of R&D expenditures, green R&D and different components of carbon emissions.