Environmental regulation and foreign investment: Evidence from China

This paper estimates the impact of environmental regulation on foreign investment using the 2003 Pollution Discharge Fee Reform in China as a quasi-natural experiment. Using a Difference-in-Differences method to investigate foreign investment from 2000 to 2007, we propose the "Pollution Deterrence Hypothesis" and the "Green Strategy Hypothesis" and provide evidence for the debate between these two hypotheses. We find that foreign investors' strategic responses to enhanced environmental regulations depend on their initial shareholder status in a firm. More specifically, after increased environmental regulation, foreign investors are less likely to invest in pollution-intensive firms in which they have held relatively small shares. However, foreign investors are more inclined to increase their shares in pollution-intensive firms in similar situations if they already held a relatively large number of shares. Based on the heterogeneous analysis, we suggest that our results are most apparent in regions with better local governance.