Environmental regulation and firms’ extensive margin decisions

Abstract

The paper explores the impacts of environmental regulation on Chinese firms’ extensive margin decisions and resulting changes in market structure and competitiveness. We find that environmental regulation significantly deters firm entry in pollution-intensive industries, while its impact on firm exit is negligible, revealing an asymmetric impact at the extensive margin. The theoretical model and empirical evidence suggest that regulation raises average productivity by selecting against low-productivity entrants and allowing high-productivity firms to enter at smaller scales. We also test for spatial spillovers and find no substantial firm relocation to unregulated areas. These results highlight market selection as a key mechanism through which environmental regulation reshapes industrial dynamics.