"Regulation to control carbon emissions forces firms to think hard about their optimal policy for carbon management. We set out a unified approach to studying the trade-offs posed by carbon pricing for firms and how they should therefore best respond. Our model reveals that although carbon pricing curtails firms' carbon emissions, polluting firms tilt their green investment mix towards more immediate yet short-lived options – such as solely reducing emissions (abatement) instead of investing in green innovation – as it becomes costlier to comply. Under emissions trading systems, larger balances of carbon credits dampen firms' efforts to reduce their carbon emissions. Our analysis reveals that carbon regulation does not necessarily decrease shareholder value if firms are sufficiently committed to reducing their carbon footprint."

Support: Digital