Abstract
We investigate whether environmental regulation reduce agency costs. We find that increases in environmental restrictions decrease liquidity and increase financial constraints. In addition, it increases the likelihood of the firms being acquired or delisted from the exchanges. Such adverse outcomes should lead the shareholders into taking actions that mitigate these risks. We notice that shareholders restructure the board of directors and incentivize CEOs with more stock ownership. These actions, in turn, reduce agency costs and lead to increases in future profitability for these firms.
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•The costs arising from the environmental regulations discipline the firms.•The conventional view argues that environmental regulation costs adversely affect firms. These firms are likely to become acquisition targets, to experience proxy fights, and are more likely to be dropped from exchanges.•However, we notice an increase in future profitability for firms that reduce agency problems after being subjected to environmental regulations.•Our findings argue for a nuanced discussion of the effects of regulation on firm profitability and behavior.