Does governmental activism affect firm leverage? Evidence from India

• Examines the impact of government environmental legislation on corporate capital structure • Highly polluting firms experienced a decline in leverage and relatedly, an increase in cost • This decline occurs in long-term debt at the expense of short-term debt • The net effect of the legislation is a cutback in real economic activity The study examines the impact of government environmental activism on firm leverage. To this end, we combine firm-level data for 2011-2020 with legislation that classifies firms by their pollution intensity. The findings reveal that highly pollution-intensive firms reduce debt to a greater extent after the legislation's implementation than less pollution-intensive firms. These results hold after controlling for relevant firm characteristics, including the macroeconomic environment. Additionally, these findings vary across ownership and among firms with differing financial constraints and rainfall sensitivities. The net effect of this legislation was to dampen real economic activity. The findings contribute to the emerging evidence on the effects of environmental legislation on firm capital structure, including its divergence across ownership and maturity, as well as the importance of firm-specific (e.g., financial constraints) and industry-specific (e.g., rainfall sensitivity) factors in driving such behaviour.