We assess the effectiveness of China’s Two Control Zones (TCZ) policy, an environmental policy that tightens the control of acid rain and the emission of sulfur dioxide (SO₂) in targeted areas. To identify the effect of the policy on industrial activities, we use the difference-in-differences (DID) method to study industry-level activities in China’s prefectures based on a unique firm-level data set covering the period from 1999–2009. We find that stricter environmental regulation led to a lower level of polluting industrial activities in TCZ prefectures, which was associated with more closures of polluting firms in targeted prefectures and more new polluting firms in non-targeted locations. In addition, our findings suggest that the TCZ policy had more pronounced effects in the coastal areas and became more effective after China changed its assessment criteria for the performance of local officials in the late 2000s.