The environmental cost of financial distress: Empirical evidence with regression discontinuity

The decarbonization of corporate activities has been extensively studied, revealing that polluting firms often incur a premium in stock returns and that financial constraints can adversely affect environmental performance. This paper advances the literature by examining whether financial distress influences the implementation of green initiatives and the level of carbon emissions within firms. Through a stakeholder-agency theory perspective, we argue that despite stakeholders’ and managers’ interests in terms of environmental protection, extreme situations such as financial distress change the incentives to environmentally conscious behavior, leading managers to take more environmental risks with the final aim of saving the company. We empirically test this thesis using a regression discontinuity (RD) design, a powerful tool to establish a causal relationship between financial distress and environmental performance and overcome typical endogeneity issues. Our analysis reveals that firms in crisis are more likely to reduce their adoption of environmentally friendly practices and to experience an increase in carbon intensity compared to firms not in distress. These findings underscore a shift in managerial priorities, where initiatives benefiting broader stakeholder interests are deprioritized in favor of those that serve the firm’s immediate needs.