The Impact of Specialized Environmental Courts on Corporate Risk‐Taking: Evidence from a Natural Experiment in China

• DOI: http://doi.org/10.1111/ajfs.12286
• Author: Kam C. Chan,Huayun Zhai,Qingzhuo Liu,Kemei Liu
• Published date: 01 February 2020
• Date: 01 February 2020

The Impact of Specialized Environmental

Courts on Corporate Risk-Taking: Evidence

from a Natural Experiment in China*

Huayun Zhai

School of Management, South-Central University for Nationalities, China

Kam C. Chan**

Gordon Ford College of Business, Western Kentucky University, United States

Qingzhuo Liu

Rady School of Management, University of California San Diego, United States

Kemei Liu

School of Management, South-Central University for Nationalities, China

Received 11 March 2019; Accepted 25 October 2019

Abstract

We examine the impact of having specialized environmental courts (SPECs) on corporate

risk-taking in China. SPECs allow judges and prosecutors to develop environmental expertise

and are accountable for environmental violations. Thus, SPECs effectively enforce environ-

mental regulations. Our findings suggest that when a firm is located in an SPEC jurisdiction,

it engages in less corporate risk-taking than an otherwise equivalent firm located in a non-

SPEC jurisdiction. The results are more pronounced for firms that receive large government

environmental subsidies and that are state-owned. Additional analysis suggests that firms

make more environmental investments when located in an SPEC jurisdiction.

Keywords Environmental judicial specialization; Corporate risk-taking; Environmental

enforcement

JEL Classification: G0, K32, Q50

*We acknowledge the helpful comments from two anonymous reviewers. Zhai acknowledges

the financial support from the Risk Management and Prevention Research Center in Colleges

and Universities of South Central University of Nationalities, which is a part of Humanity

and Social Science Research Institute, Hubei Province, the Foundamental Research Funds for

the Central Universities, and the Research on the Transformation of Government’s Ecological

Environment Governance and System Innovation Fund of South Central University of

Nationalities. The usual caveats apply.

**Corresponding author: Gordon Ford College of Business, Western Kentucky University,

Bowling Green, KY 42101, United States. Tel: +1-270-745-2977, email: johnny.chan@wku.edu.

Asia-Pacific Journal of Financial Studies (2020) 49, 99–118 doi:10.1111/ajfs.12286

©2020 Korean Securities Association 99

1. Introduction

Rapid economic growth in China has undoubtedly raised the economic standards

and welfare of the Chinese people. However, it has also come with environmental

concerns. Du et al. (2018) and Ji et al. (2019) suggest that pollution has become a

major challenge in China in recent years. To tackle various forms of pollution, the

Chinese government has been implementing aggressive environmental regulations

(Zhu et al., 2019).

The literature suggests that environmental regulations impact firm operations in

all respects and not just in terms of environmental practices. Studies have primarily

examined the effects of these regulations on corporate strategies and environmental

investments (EI; Jackson and Apostolakou, 2010; Pagell et al., 2013), corporate

investments (Madsen, 2009), corporate innovation and competitiveness (Ambec and

Lanoie, 2008; Iraldo et al., 2011), and stock returns (Oestreich and Tsiakas, 2015).

However, the impacts of environmental regulation enforcement on corporate

risk-taking remain underexplored. Several related studies (Sharfman and Fernando,

2008; Muhammad et al., 2015; Khairollahi et al., 2016) suggest that as a firm’s cor-

porate environmental performance (CEP) improves, its levels of corporate risk-tak-

ing decrease, though it is not clear whether environmental regulation enforcement

impacts corporate risk-taking.

We contend that a firm’s environmental performance in large part responds to

the enforcement of regulations. Merely imposing environmental regulations without

enforcement does not drive firms to pursue environmental performance improve-

ments. Thus, it is imperative to study environmental regulation enforcement.

The purpose of this paper is to examine the impacts of environmental enforce-

ment on corporate risk-taking in China. Specifically, we leverage a natural experi-

ment conducted in China where certain jurisdictions (provinces, cities, and

counties) have established specialized environmental courts (hereafter SPECs) to

examine environmental cases. We expect to find that such SPECs help judges and

prosecutors develop environmental regulation expertise and hold them accountable

for environmental violations. Thus, SPECs can accelerate trials on environmental

violations, enforce environmental regulations, and thus shape the risk-taking behav-

iors of firms.

We argue that when a firm is based in an SPEC jurisdiction, the firm is subject

to heavy legal monitoring. Therefore, as background risks facing a firm increase, the

firm’s appetite for other forms of risk-taking decreases (Gollier and Pratt, 1996).

Thus, firms based in SPEC jurisdictions pursue risk-taking less than those based in

non-SPEC jurisdictions.

Using data for 2004–2016 and a difference-in-difference (DID) research design,

we examine the risk-taking behaviors of firms in SPEC vis-

a-vis non-SPEC jurisdic-

tions to test our hypothesis. To the best of our knowledge, China is one of few

countries that uses SPECs to accelerate environmental trials to strengthen environ-

mental regulation enforcement. Thus, the effectiveness of SPECs, if existent, would

H. Zhai et al.

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