To examine the impact of environmental regulation on corporate carbon activities from a capital market perspective, this study integrates illegal emission penalty announcement information and corporate carbon emission data with micro-level data of listed enterprises. Using a sample of Chinese listed companies from 2009 to 2022 and employing a fixed-effects model regression analysis, it investigates how investors adjust corporate carbon risk premium following the disclosure of environmental penalty and the underlying mechanisms. The findings reveal that corporate carbon risk premium significantly increases after emission-related penalties, with investor sentiment serving as the primary transmission channel- such penalties reshape investors’ carbon emission projections by altering investors’ sentiment. Furthermore, the impact of penalties exhibits significant heterogeneity depending on enterprise ownership type and monitoring intensity, and is moderated by firms’ environmental information disclosure levels and ESG performance.