Air Pollution, Environmental Violation Risk, and the Cost of Debt: Evidence from China

Although a firm's exposure to air pollution-related risk has become an important factor that creditors cannot ignore in the procedure of lending decision making with the aggravation of air pollution, empirical evidence on whether and how air pollution affects the cost of debt has been relatively scarce. Employing a series of Chinese listed firms from the main board of the Shanghai and Shenzhen Stock Exchanges covering 2014 to 2018, our research responds to this research gap by exploring how air pollution-induced environmental violation risk affects the cost of debt by constructing an assessment system of firms' environmental violation risk. The results shed light on an issue that firms exposed to higher concentrations of air pollution may suffer a higher environmental violation risk, resulting in a higher debt cost. In addition, a further analysis shows that environmental regulatory pressure and heavily polluting firms enhance the influence of air pollution on the cost of debt, while state-owned firms and firms' economic contributions weaken the influence of air pollution on the cost of debt. Our research is conducive to highlighting not only the importance of environmental governance for mitigating the cost of debt to the firms exposed to air pollution, but also its importance to creditors exposed to their clients' environmental violation risk and default risk.