["The World Economy, EarlyView. ", "\nABSTRACT\nEmploying the quasi‐natural experiment of the emission reduction targets of the 11th Five‐Year Plan in 2006, this study investigates the impact of environmental regulation on FDI stocks and flows in China. We find that stringent environmental regulations lead to a “shift” of FDI to less regulated regions due to the “rising cost effect” and “innovation compensation effect”. The effect is prominent for firms with a high capital‐labor ratio, that are state‐owned, in non‐high‐tech or pollution‐intensive sectors. An examination of FDI flows indicates that the observed redirection of FDI is largely driven by foreign investors favouring regions with lenient environmental regulations. Further investigation focusing on parent‐subsidiary relationships reveals that environmental regulations lead to a decrease in the number of subsidiaries established locally by enterprises in regions with stringent regulations. Subsidiaries receive more FDI when the gap in environmental regulation intensity between the location of the parent enterprises and the location of the subsidiaries is larger.\n"]