The effect of stringent environmental regulation on firms’ TFP—new evidence from a quasi-natural experiment in Chongqing’s daily penalty policy

Using data from Chinese industrial firms from 2003 to 2012, this paper utilizes a difference-in-differences approach to investigate the impact of stringent command-and-control environmental regulations on firm productivity through Chongqing’s daily penalty policy (DPP). Unlike the previous command-and-control environmental regulations of “low penalty amounts”, “one-size-fits-all”, and “one-off penalties”, the DPP with “high deterrent effect” and “high cost of non-compliance” imposes continuous high fines of a fixed daily amount on persistent environmental violators. This is conducive to improving environmental quality while significantly increasing firms’ total factor productivity (TFP). It provides empirical evidence for the validity of the strong Porter hypothesis in developing countries. A series of robustness tests ensure the credibility of these findings. The mechanism analysis shows that DPP can improve TFP of firms by stimulating the innovation compensation effect of firms and crowding out high polluting and inefficient firms in the industry. Heterogeneity analysis shows that the productivity of highly polluting, private, non-exporting and small-scale firms is significantly increased under the influence of DPP. This study provides new ideas for improving command-and-control environmental regulation to bring into play its Porter effect, and offers experiences and insights for regulating firms’ emission behaviors to achieve a win–win situation for both economic growth and green development.