Financial Frictions and Pollution Abatement Over the Life Cycle of Firms

Abstract

Using US firm-level data, we document significant differences in pollution abatement activities over the life cycle of firms. Under financial constraints, smaller and younger firms invest more in capital and engage less in pollution abatement; as they accumulate more net worth, their abatement activities accelerate, and their emission intensity reduces. Motivated by this evidence, we develop and quantify a heterogeneous firm model to study the relation between financial frictions, capital investment, and pollution abatement. In the model, smaller and younger firms prefer capital investment over pollution abatement because the returns from the former are higher than those from the latter. More importantly, we show financial frictions make environmental regulation sub-optimal at any level: they reduce aggregate welfare gain by 40%. Finally, we show that green loan policies, even without monitoring, are considerably effective in reducing emission intensity.

Keywords: Financial frictions, pollution abatement, heterogeneous firms, environment, climate;

JEL Classification: E1, E2, E3, E6, G1, G3, K3, Q5