Legal Environmental Governance and Zombie Firm Resolution: Evidence From the Establishment of Environmental Courts in China

ABSTRACT This study investigates whether the establishment of environmental courts accelerates the market exit of zombie firms in China's manufacturing sector. Exploiting the staggered introduction of environmental courts across cities between 2003 and 2014, we employ a multiperiod difference‐in‐differences design using firm‐level panel data. Our findings indicate that environmental courts significantly reduce the persistence of zombie firms. These results are robust to alternative specifications, matching methods and definitions of zombie firms. Mechanism analyses reveal that environmental courts alleviate financing constraints and strengthen performance‐based selection by widening gross profit margin differentials. The effects are more pronounced in regions with greater environmental policy emphasis, more developed commercial environments and among firms with weaker liquidity. Overall, this study provides causal evidence that rule‐based environmental judicial institutions can promote efficient firm exit and improve resource allocation during economic transitions.