Dynamic Carbon Emission Management

Abstract

The control of carbon emissions by policymakers poses the new corporate challenge of developing an optimal carbon management strategy. We provide a unified model that characterizes how firms should optimally manage emissions through production, green investments, and carbon trading, as well as the implications for asset prices. Under a carbon trading scheme, firms adopt precautionary policies such as under-producing compared to a laissez-faire benchmark. Perhaps surprisingly, firms with a large stock of credits are less committed to reducing emissions. More generally, carbon regulation does not necessarily reduce firm value and, furthermore, induces firms to tilt towards more immediate yet transient types of green investment as it becomes more costly to comply. We also show that polluting firms command a higher risk premium.