The Impact of Carbon Emission Trading Policy on Enterprise ESG Performance: Evidence from China

The carbon emission trading system profoundly impacts enterprises’ sustainable development as an important market incentive environmental regulation tool. Through data collected from Chinese A-share listed enterprises in Shanghai and Shenzhen from 2011 to 2019 and Bloomberg ESG score data, this paper empirically analyses the impact of carbon emission trading policy on enterprise ESG performance and its channel mechanism using the difference-in-difference (DID) method.

Results of this study indicate that carbon emission trading policy improves enterprise ESG performance significantly, and robustness tests confirm these findings. Carbon emission trading policy can encourage enterprises to enhance their R&D investments and promote internal controls, ultimately enhancing their ESG performance.

Additionally, carbon emission trading policy positively impacts ESG performance in low-carbon enterprises, enterprises where the CEO is separated from the company, enterprises with a high degree of digital transformation, and enterprises receiving high government subsidies.

This paper extends our research into the economic implications of carbon emission trading policy, enriching the literature on market-based environmental regulation policies’ impact on enterprise ESG performance. With respect to governments’ use of carbon emission trading to regulate enterprises environmentally, this paper provides theoretical guidance. It has significant practical implications for improving enterprise ESG performance and sustainability.

Carbon dioxide emissions and other greenhouse gases are the primary cause of global warming. With climate change caused by carbon emissions and other factors, the international community is trying to coordinate national resources through market-based mechanisms and find effective policies to reduce emissions and save energy.

The Kyoto Protocol entered into force in 2005, limiting greenhouse gas emissions for the first time in human history. Following the Kyoto Protocol, developing countries can sell their carbon emissions to developed countries through the Clean Development Mechanism (CDM). While promoting sustainable development and reducing the carbon emissions of developing countries, developed countries can also offset their obligation to reduce carbon emissions. Carbon trading is an emerging environmental energy trading approach born under this system, and it is a market mechanism to promote global greenhouse gas emission reduction. The European Union Emissions Trading Scheme (EU-ETS) is the first carbon trading system in the world. Since its launch in 2005, it has increased with the development of global carbon finance. UE-ETS covers 28 countries in the European Union, occupying the largest share of global trading volume, achieving good results in controlling carbon emissions and the greenhouse effect and protecting the ecological environment.

Approximately 30% of global carbon emissions are attributed to China, the largest emitter in the world. In addition to seriously polluting the environment, large quantities of carbon dioxide restrict the development of the Chinese economy. To achieve carbon peaking and carbon neutrality, eight provinces and cities in China have established pilot markets in carbon emission trading since 2013, including Beijing, Shanghai, Tianjin, Chongqing, Guangdong, Shenzhen, Hubei, and Fujian. With China’s continued rapid economic growth, carbon emissions have increased significantly, thus promoting the development of carbon financial trading. Several pilot carbon emission trading markets in China have reached 330 million tons of trading volume by April 2021, with a turnover of around 7.4 billion CNY, which has led to a significant reduction in emission levels.

Research on the beneficial results of carbon emission trading has steadily increased in recent years because of the environmental and economic benefits and technological innovations that can be achieved through carbon emission trading. The transition to the low carbon economy and the carbon trading system is positively correlated with environmental impacts. The carbon emission trading system can significantly improve heavy polluters’ green development efficiency and promote their green transformation. In a study by Chen et al., carbon emissions trading was proven to significantly reduce greenhouse gas emissions in both enterprises and provinces.

According to Liu and Zhang, a trading scheme for carbon emissions in China led to the rapid development of non-fossil fuel energy sources. In pilot areas, the economic effects of carbon emissions trading are found to increase employment and alter employment patterns. In addition, carbon emission trading can improve enterprises’ financial performance and asset-liability ratios. As Liu et al. reported, carbon emission trading negatively impacted the stocks of most industries, but as the market developed and improved, it had a different impact on the stock prices in different industries.

In terms of technological innovation, Texico et al. found that the EU-ETS was more effective in stimulating low-carbon technological innovation than in implementing low-carbon technical change. Zhang et al.’s study found that carbon emission trading at this stage inhibited green technological innovation but reduced carbon emissions. However, Zhou and Wang’s study reached the opposite conclusion, concluding that China’s carbon emissions trading policy had a significant effect on promoting green technology innovation in pilot cities.

Recently, the Chinese government has greatly emphasized environmental safeguards, emphasizing that “clear waters and green mountains are just as valuable as gold and silver mountains. While promoting carbon emission reduction, a series of policies and regulations were introduced, requiring environmental protection, fulfilling social responsibilities, and optimizing corporate governance to ensure sustainable economic growth. With the deep promotion of the concept of green development, the ESG system consisting of three elements (environment (E), society (S), and corporate governance (G)) has attracted more and more attention from market players. ESG elevates the issues in corporate social responsibility (CSR) to the areas of investor concern and measures the enterprise’s contribution to environmental, social, and corporate governance through relatively quantitative indicators. Compared with traditional investment concepts, the ESG concept has a more long-term vision, which can realize the comprehensive value maximization of the economy, environment, and society. Experts and scholars are studying the ESG performance of enterprises in greater depth. In their study utilizing ESG ratings as a measure of corporate green innovation, Tan and Zhu found that the quantity and quality of green innovation can be impacted by ESG ratings. Environmentally sensitive enterprises have a positive correlation between their performance on ESG indicators and their return on equity and Tobin’s value. Zeng and Jiang analyzed the impact mechanism of ESG from three perspectives: government, market, and enterprise, and found that higher ESG ratings are conducive to enterprise performance improvement. Additionally, green financial policies and the development of green finance can also effectively enhance enterprise ESG performance  showed that the higher their enterprise ESG performance, the stronger their ability to innovate and develop sustainably. Poor internal governance of an enterprise can also harm its ESG performance. For example, the equity pledge behavior of a company’s executives can have a significant negative impact on enterprise ESG performance.

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