Spillover Effects of Environmental Enforcement Actions through Private Lending

Abstract

This study examines how exposures to Environmental Protection Agency (EPA) enforcement actions against a borrower increase lenders’ incentives to monitor other borrowers’ polluting activities, resulting in pollution reduction by their other borrowers. Findings reveal that, following the enforcement actions, firms borrowing from exposed lenders significantly reduce their toxic releases relative to firms borrowing from unaffected lenders. Additional findings reveal that the spillover effects are more pronounced when lenders’ environmental monitoring incentives are greater and when they exert greater influence over borrowers. We also find that lenders are more likely to terminate lending relationships with borrowers that do not sufficiently reduce polluting activities, which suggests that termination is a credible threat to nonresponsive borrowers. Taken together, our study’s findings suggest that the EPA can achieve its environmental goals–reaching a broader set of firms while limiting the scope of environmental enforcement actions–by leveraging the private lending markets.

Keywords: EPA Enforcement, Private Lending, Spillover Effect

JEL Classification: G21, G32, M41