Moral Hazard and Tradeable Pollution Emission Permits

Alvarez Francisco () and Ester Camiña
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Alvarez Francisco: Department of Fundamentos del Análisis Económico II, Universidad Complutense, 28223 Pozuelo de Alarcon, Madrid, Spain
Authors registered in the RePEc Author Service: Francisco Alvarez Gonzalez ()

The B.E. Journal of Theoretical Economics, 2014, vol. 14, issue 1, 415-444

Abstract: We consider a market for pollution emission permits in a model in which pollution, generated as by-product of firm’s activity, is determined as the sum of firm-specific random shocks and each firm’s abatement effort. In such a setting, an expected utility maximizing society demands an efficient abatement effort from each firm. We assume that the abatement effort is decided by each firm and is not observed by the environmental regulator. This leads to a moral hazard problem between firms (agents) and the regulator (principal). The regulator assigns contracts to each firm, each contract consisting of an amount of permits and a linear fine for over-polluting firms. We distinguish those policies where the regulator assigns a low number of permits (restrictive policies) and policies where the number of permits to distribute is high (permissive policies). We show that in a context of restrictive policies there exist policies that achieve efficiency and do not need to discriminate in terms of penalties among over-polluting firms when a market for permits is allowed to operate. We also find that the regulator can set up policies with low penalty levels for almost all firms. Finally, we show that in a context of permissive policies, the market leads to the same efficiency-inducing fine scheme than the corresponding one under autarky.

Keywords: moral hazard; emission permits market; efficiency-inducing policies (search for similar items in EconPapers)
JEL-codes: D21 D82 (search for similar items in EconPapers)
Date: 2014
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Working Paper: Moral hazard and tradeable pollution emission permits (2008)
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DOI: 10.1515/bejte-2013-0072

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