Abstract
We analyze the interplay between firms' financial constraints and environmental policy, for which we introduce emission externalities and industry equilibrium in the Holmström and Tirole (1997) workhorse model of corporate finance. Importantly, financial constraints do not unambiguously call for a less stringent cap on emissions and consequently a lower price of emissions. This is only the case when firms' and ultimately the industry`s own funds are sufficiently constrained. Otherwise, the optimal policy is even stricter than a Pigouvian benchmark, as the resulting output restriction of more polluting firms and with it a higher product price cause a positive pecuniary externality on less polluting firms, relaxing their financial constraints. Under financial constraints also the initial allocation of pollution rights is no longer welfare neutral.
Invited by: Tasos Xepapadeas / Environmental Group
Local Organizer: Niko Jaakkola