Emission Caps and Investment in Green Technologies

Abstract

To the extent that firms don't internalise the negative externalities of their CO2 emissions, government intervention is needed to curb global warming. We study the equilibrium interaction between firms, which can invest in green technologies, and government, which can impose\emission caps but has limited commitment power. Two types of equilibria can arise: If firms anticipate caps, they invest in green technologies. These investments have positive spillover effects, lowering the aggregate cost of emission reductions for all firms, thus making the government willing to cap emissions. If firms anticipate no caps, they don't invest in green technologies, and the government finds it too costly to cap emissions. A large fund, engaging with firms' management to foster investment in green technologies, can tilt equilibrium towards emission caps.

Keywords: Climate change, ESG finance, CO2 emissions

JEL Classification: Q54, Q58, K20, H40, G30