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Carbon trade-offs: how firms respond to emission controls

Author

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  • Bustamante, Maria Cecilia
  • Zucchi, Francesca

Abstract

Regulation to control carbon emissions challenges firms to develop optimal carbon management policies. We set out a unified approach to study the trade-offs carbon pricing poses for firms and how they should therefore best respond. Our model shows that while carbon pricing curtails firms’ carbon emissions, polluting firms tilt their green investment mix towards more immediate yet short-lived options – such as solely reducing emissions (abatement) instead of investing in green innovation – as it becomes costlier to comply. Under emissions trading systems, larger balances of carbon credits dampen firms’ efforts to reduce their carbon emissions. Our analysis reveals that carbon regulation does not necessarily reduce shareholder value if firms are sufficiently committed to reducing their carbon footprint. JEL Classification: G30, G31, O30, D62

Suggested Citation

  • Bustamante, Maria Cecilia & Zucchi, Francesca, 2023. "Carbon trade-offs: how firms respond to emission controls," Research Bulletin, European Central Bank, vol. 109.
    • Handle: RePEc:ecb:ecbrbu:2023:0109:
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    More about this item

    Keywords

    carbon emissions; Carbon pricing; green investment;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • O30 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - General
    • D62 - Microeconomics - - Welfare Economics - - - Externalities

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