Do environmental penalties matter to corporate innovation?

Environmental penalties play a crucial role in enforcing corporate environmental compliance and performance. In this paper, we examine whether and how government environmental violation penalties influence corporate innovation. Using a large sample of Chinese-listed firms, we find that firms subjected to environmental penalties tend to reduce their investment in R&D, resulting in a reduction in both patent applications and granted patents. These adverse effects intensify with the severity of the penalties and contribute to raising the cost of capital for penalized firms. However, our analysis also reveals that the number of green patent applications tends to increase post-penalty imposition. These results indicate that companies that are subject to environmental penalties may shift their long-term investment strategy from general innovation towards environmental initiatives.