Internalising externality: the impact of environmental pollution liability insurance on the green transformation of Chinese heavy-polluting firms

Environmental protection and green development have become a common goal for countries and organisations worldwide, increasing pressure on firms to implement green transformation (GT) strategies. Environmental pollution liability insurance (EPLI) is a powerful risk management tool that transfers pollution liability risks outside the firm. This study examines the impact of EPLI coverage on firms’ GT progress using data from Chinese heavy-polluting firms. The empirical results show that EPLI-covered firms are likely to promote GT, with the effect persisting over time. The study then discusses the potential mechanisms to explain this positive impact and finds that EPLI imposes additional compliance costs on firms. However, these additional compliance costs do not exacerbate firms’ financial constraints because EPLI coverage improves the availability of external financing. EPLI corverage also improves firms' risk management practices. Finally, the magnitude of EPLI’s impact depends on firms’ bargaining power in their relationship with the local government.