The unintended consequences of the area-based evaluation mechanism reform on green innovation: Evidence from highly polluting firms in China

In emerging markets characterized by heavy government intervention, government-dominated resource allocation plays an important role in cultivating sustainable firms. This paper investigates its effectiveness in fostering corporate green innovation by exploiting a quasi-experimental setting in China. We find that the government-led resource allocation reform known as the Area-based Evaluation Mechanism Reform detrimentally influences green innovation activities of highly polluting firms. We attribute the negative effect to the short-termism channel rather than the quiet life channel, as the reform drives firms toward short-termism, crowding out their incentives for long-term environmental sustainability. We also investigate how this reform interacts with local government incentives. Although the reform delivers short-term economic gains, these benefits do not justify the observed reductions in corporate green innovation, productivity, and innovative efficiency. Our empirical evidence highlights the unintended negative consequences of the policy instrument for sustainable development and the need to place greater focus on environmental targets in emerging markets.