Pollution liability insurance and corporate environmental compliance in China

Abstract This study examines the effect of a pollution liability insurance mandate on corporate environmental compliance in Shenzhen, China. We employ a triple differences design, comparing electroplating and circuit board (ECB) manufacturing firms, mandated to purchase insurance, to industries and a neighboring city without the mandate. Results show a 0.48 reduction in annual environmental violations per firm (a 72% decrease) across all Shenzhen ECB firms. Within the Shenzhen ECB industry, only about half of firms comply. Notably, both insured and uninsured firms reduced violations, consistent with anticipation that (eventual) premiums would depend on past violations. The insurance could generate two opposing forces: premium‐based incentives to reduce violations versus moral hazard among the insured. We find suggestive evidence that insured firms' environmental compliance gains are partially offset by moral hazard. Our findings demonstrate that premium‐based incentives dominate and effectively counteract market failures due to asymmetric information, increasing environmental compliance on net.