Abstract: Based on the research of Antweiler et.al (2001) and combining the incomplete contract theory, this paper develops a general model of pollution discharge, and then uses the Difference-in-Difference method with data of two-digit manufacturing industries of China to examine the impact of the contract institution on the environmental quality. The empirical result shows that contract institution is the key factor of pollution discharge. Moreover, firms are apt to invest special emission reduction capital to reduce pollution and improve environment quality in the region where contract institution is comparatively complete.However, this positive effect fails to be strengthened in higher contract intensive industries. This abnormal result can be explained by pollution intensity of the industry itself. The previous result is still stable after controlling a series of factors such as per capita capital, human resources, foreign direct investment and external trade.