Climate Regulation and Emissions Abatement: Theory and Evidence from Firms’ Disclosures

Abstract

We construct measures of firms' beliefs about climate regulation, plans for future abatement, and current emissions mitigation from responses to the Carbon Disclosure Project. These measures vary in a pronounced, distinctive fashion around the Paris announcement. A dynamic model of a representative firm exposed to a future carbon levy, trading-off mitigation against capital growth, facing convex abatement adjustment costs does not fit the data; but a two-firm model with cross-firm information asymmetry and reputational externalities does. Out-of-sample, the model predicts reversals following the US exit from the Paris agreement. We conclude that abatement is strongly affected by firms' beliefs about climate regulation, and cross-firm interactions amplify the impact of regulation.

Keywords: climate change, climate regulation, carbon emissions, dynamic models, belief heterogeneity, reputation, abatement

JEL Classification: G31, G38, Q52, Q54