The Green Costs of Debt Overhang: Evidence from Local Government Debt Restructuring

Abstract

We investigate the environmental implications of debt overhang using China's large-scale local government debt restructuring in 2015 as a natural experiment. We find that after the debt restructuring, cities with previously heavier debt burdens experience greater improvements in air quality. These cities also become more likely to close coal-fired power plants, increase clean energy production, and raise pollution penalties. Listed firms in these cities file more green patent applications. Alternative explanations, such as top-down environmental inspections and pre-existing trends, cannot explain the findings. Our study highlights the critical role of governments' financial constraints in shaping environmental regulations and outcomes.

Keywords: Debt restructuring, local government debt, debt overhang, green finance, air pollution

JEL Classification: H74, Q53, Q58, G34