Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/253669 
Year of Publication: 
2021
Publisher: 
ZBW – Leibniz Information Centre for Economics, Kiel, Hamburg
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.
Subjects: 
pigou tax
financing
climate change
JEL: 
O16
L16
H23
Document Type: 
Working Paper

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