Abstract: China’s large-scale agricultural production generates enormous quantities of straw, a significant portion of which remains underutilized, leading to environmental problems such as open burning and increased greenhouse gas emissions. Promoting off-field, and high-value straw utilization is a critical strategy for agricultural carbon reduction and sustainable development. Farm households’ decision to sell straw is the pivotal first step in this industrial value chain. However, despite clear social and environmental benefits, farm households’ participation in the straw market remains limited, largely due to the positive externality problem where high private costs of collection and transport are not offset by sufficient private returns. While existing literature has explored single policy instruments, few studies has systematically investigated the combined effects of formal policy regulation and informal normative cognition, or distinguished between the selling decision and the selling intensity. Grounded in institutional embeddedness theory, this study develops an integrated analytical framework to examine farm households’ straw-selling behavior as a two-stage decision process. We utilize survey data from 715 farm households in Huanggang City, Hubei Province. To address potential sample selection bias, a Heckman two-stage model is employed to analyze households’ initial “selling decision” and subsequent “selling intensity”. The robustness of our findings is further validated using an instrumental variable (IV)-Heckman model to account for potential endogeneity. The empirical results indicate that both policy regulation and normative cognition are significant drivers of farm households’ straw-selling decisions. A key finding is the existence of a significant complementary effect between these two factors in the initial selling decision stage. This synergistic interaction, however, does not extend to the subsequent stage of selling intensity. Furthermore, significant group heterogeneity is observed. The impact of policy regulation and normative cognition on straw-selling decisions varies markedly among farm households with different locational characteristics and cultivated land sizes. This research demonstrates that farm households’ engagement in the straw market is shaped by a dual mechanism of external rules and internal beliefs. Effective policy should move beyond simple regulation to activate farm households’ endogenous motivations by leveraging the guiding function of normative cognition. Policymakers should design interventions that foster synergy between formal and informal norms. The pronounced group heterogeneity invalidates a “one-size-fits-all” approach, necessitating differentiated strategies. For far collection point households, improving the density of the collection points is key, while for small-scale households, incentive-based policies should be prioritized, and for large-scale households, constraint-based regulations may be more effective. Such targeted policies are essential for maximizing high-value straw utilization and advancing high-quality agricultural development.