From Control to Incentive: How Market-Driven Environmental Regulation Shapes ESG Performance in Manufacturing Industries

Market-based environmental regulation plays a crucial role in aligning industrial development with sustainability goals. Taking the implementation of China’s Environmental Protection Tax (EPT) in 2018 as a quasi-natural experiment, this study employs a difference-in-differences framework using an unbalanced panel of 2677 manufacturing firms from 2010 to 2022 to identify the causal effect of the EPT on corporate ESG performance (MFESG). The findings reveal that the implementation of market-based environmental regulation significantly elevates the ESG performance of manufacturing firms. This positive influence is realized not only directly but also indirectly through improved financing accessibility and innovation capacity. Moreover, the enhancement effect is uneven across firms: non-state-owned enterprises, firms unaudited by the Big Four, and those situated in China’s eastern regions exhibit stronger ESG responses. Across the three ESG pillars, the environmental and social dimensions benefit most from the EPT, suggesting that market mechanisms can be effective catalysts for sustainable industrial upgrading.