Environmental policy, green governance, and institutional investor divestment

This study investigates how China’s Environmental Protection Tax Law has influenced institutional investors’ capital allocation decisions towards pollution-intensive firms, and how corporate green governance strategies shape this relationship. Grounded in signalling and legitimacy theories, we posit that stricter environmental regulation heightens perceived compliance costs and cash-flow risks, leading risk-averse institutional investors to reallocate funds away from high-polluting firms. Using a difference-in-differences framework on a balanced panel of 1600 A-share listed firms from 2014 to 2023, we find that the enactment of the Environmental Protection Tax Law significantly intensified institutional investors’ divestment from polluting firms. Substantive green transformation does not immediately mitigate this effect, suggesting a lag in market recognition of genuine green efforts, whereas symbolic greenwashing is rapidly detected and penalised. Further analyses show that investor avoidance is less pronounced in regions with greater financial development, digital transparency, and stronger corporate governance, but stronger where environmental enforcement is tighter. Our findings contribute to the literature on sustainable finance and institutional investment by revealing how regulatory signals and governance credibility interact to shape capital market responses in emerging economies.