Environmental verification mandates, ESG performance, and capital resource allocation

Abstract

This thesis consists of two chapters that investigate the long-lasting impacts of Environmental Verification Mandates (EVMs) on Chinese companies that have undergone the process of initial public offerings (IPOs) and seasoned equity offerings (SEOs), respectively. Chinese regulators have implemented the EVMs that firms in the selected high-polluting industries satisfy the environmental verifications before these firms get approval for IPOs or SEOs during the period of January 2008 to October 2014. This setting allows me to identify the treatment and control groups of firm samples and to document the role of the mandated environmental verifications in shaping firms’ environmental performance and affecting corporate decision-making. Specifically, in the first chapter, I examine the post-IPO environmental performance of the treatment firms that are subject to EVMs at the IPO stage (i.e., compliance firms). Using environmental rating, green patent application, and PM2.5 intensity to proxy for environmental performance, the study shows that compliance firms exhibit a better post-IPO environmental performance than other firms in the high-polluting industries that do not comply with EVMs (i.e., non-compliance firms). The results are more pronounced when CEOs of compliance firms are expected to have higher capabilities to comply with government requirements. In addition, the effects of EVMs are weakened when the IPOs of compliance firms are subject to greater institutional pressure from local governments. I further investigate the dynamic pattern of the effects. In particular, the leading advantage of compliance firms’ environmental performance is significantly weakened after veteran CEOs and veteran corporate directors have departed. In contrast, I find an improvement in the firm’s environmental performance after this firm recruited a veteran CEO from an EVM-compliance firm. Lastly, I show that the implementation of EVMs has more pronounced effects on compliance firms’ post-IPO environmental performance when local environmental regulations become more stringent. Taken together, the EVMs during the IPO process have a persistent effect on firms’ post-IPO environmental performance. The second chapter examines how SEO applicants respond to mandatory environmental verifications and the resulting allocation of corporate resources. I find that EVM-compliance SEO applicants strategically reduce pollution by underproducing in the pre-SEO period. Such underproduction helps increase the likelihood of SEO approval. In contrast, non-EVM-compliance SEO applicants experience a decrease in the likelihood of SEO approval if they undertake the strategy of underproduction. The benefit of SEO approval is more pronounced for the underproduction strategy of those EVM-compliance SEO applicants with limited access to capital and those facing less environmental pressure from local governments. My additional analyses suggest that compliance SEO applicants with underproduction start to over-produce in the post-SEO period and have a better post-SEO firm performance; in the meanwhile, these applicants resort to misleading environmental disclosure practices to cover up the deteriorating environmental performance. Lastly, market reactions to the announcements of SEO approval are significantly negative (positive) when ESG funds hold (do not hold) the stocks of the EVM-compliance SOE firms with suspected production manipulation. Overall, this research shows how EVMs affect corporate behaviors in the pre-and post-SEO periods, shedding light on the role of EVMs in capital resource allocation through the SEO process.