A corporate finance perspective on environmental policy

Florian Heider and Roman Inderst

No 345, SAFE Working Paper Series from Leibniz Institute for Financial Research SAFE

Abstract: This paper examines optimal enviromental policy when external financing is costly for firms. We introduce emission externalities and industry equilibrium in the Holmström and Tirole (1997) model of corporate finance. While a cap-and-trading system optimally governs both firms' abatement activities (internal emission margin) and industry size (external emission margin) when firms have sufficient internal funds, external financing constraints introduce a wedge between these two objectives. When a sector is financially constrained in the aggregate, the optimal cap is strictly above the Pigouvian benchmark and emission allowances should be allocated below market prices. When a sector is not financially constrained in the aggregate, a cap that is below the Pigiouvian benchmark optimally shifts market share to less polluting firms and, moreover, there should be no "grandfathering" of emission allowances. With financial constraints and heterogeneity across firms or sectors, a uniform policy, such as a single cap-and-trade system, is typically not optimal.

Date: 2022
New Economics Papers: this item is included in nep-cfn, nep-ene and nep-env
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Related works:
Working Paper: A Corporate Finance Perspective on Environmental Policy (2022)
Working Paper: A Corporate Finance Perspective on Environmental Policy (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:safewp:345

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