From compliance to capability: How environmental certification drives corporate ESG transformation

We examine whether government environmental incentives can resolve the underinvestment problem in corporate sustainability by exploiting China's Green Factory Certification program as a quasi-natural experiment. Using difference-in-differences estimation on Chinese listed firms from 2010–2024, we find that certification increases Environmental, Social, and Governance (ESG) performance by approximately 3% relative to the control group. The effect operates through two complementary channels: green innovation investment that generates firm-specific capabilities, and operational efficiency gains that improve green total factor productivity. The effects are significantly stronger for non-state-owned enterprises and firms with lower environmental public concern, indicating that market-based incentives amplify policy effectiveness. Certification most strongly improves environmental performance, followed by governance and social dimensions, suggesting spillover effects through enhanced organizational capabilities. Our findings demonstrate that environmental certification transcends compliance by building capabilities that address coordination failures in ESG investment, providing theoretical foundations for understanding how government intervention drives corporate sustainability transformation.