Regulatory penalties and ESG outcomes: a nonlinear governance mechanism

This study examines the nonlinear relationship between environmental penalty intensity and corporate ESG performance, as well as the contextual conditions under which this relationship changes. Using panel data for Chinese A-share listed companies from 2013 to 2023, we employ a fixed-effects model, supplemented by instrumental variable, propensity score matching, and Heckman two-step approaches, to address potential endogeneity and sample selection concerns. The results reveal a significant U-shaped relationship between environmental penalty intensity and ESG performance: at low levels of penalty intensity, increased penalties suppress ESG performance, whereas beyond a critical threshold, further penalties promote ESG improvement. Further analyses show that this nonlinear effect is shaped by three moderating conditions. Media attention strengthens the positive segment of the U-shaped relationship by increasing external scrutiny and reputational pressure. Political connections weaken the governance effect of environmental penalties by buffering firms from regulatory and market discipline. Green technological innovation positively moderates the U-shaped relationship by enhancing firms’ internal capability to convert regulatory pressure into substantive environmental upgrading and ESG improvement. Heterogeneity analysis further indicates that the U-shaped relationship is more pronounced among firms with low goodwill, firms located in eastern regions, and firms facing lower financing constraints. This study contributes to the literature by moving beyond a linear perspective on environmental regulation and by identifying the external monitoring, institutional buffering, and internal capability conditions under which environmental penalties become effective governance mechanisms for improving ESG performance.