Does local government debt expansion exacerbate corporate climate risk exposure?

Abstract

Using a dataset of Chinese A-share manufacturing firms from 2007 to 2021, this study evaluates the environmental consequences of local government debt (LGD) expansion. While the economic effects of LGD have been extensively examined, its environmental repercussions—particularly with respect to corporate climate risk exposure—remain insufficiently understood. Our empirical results show that a one-standard-deviation increase in LGD is associated with a 0.045-standard-deviation rise in corporate climate risk exposure. Two primary transmission channels are identified. First, LGD expansion crowds out long-term bank credit, pushing firms toward costly informal financing and constraining green investment. Second, growth-oriented local governments strategically relax environmental enforcement, reducing regulatory pressure for low-carbon transitions. These effects are more pronounced among low-cash, asset-intensive, and highly polluting firms. Moreover, banking competition intensifies these environmental costs when government-market relations are distorted, whereas LGD governance reforms effectively mitigate them. This study provides micro-level evidence of the environmental externalities of LGD and offers policy insights for coordinating fiscal–financial reforms to mitigate climate risks.