Abstract
Allocation of allowances in an emission trading system (ETS) may affect firms' investments in new technologies. In this paper, we investigate how the incentives to invest depend on the regulator's expected response to these investments, assuming that allowances are allocated in proportion to output (output-based allocation (OBA)). If the regulator has commited to the allocation factor, OBA tends to stimulate investments in cleaner technologies, due to higher output and increased price of allowances. On the other hand, if each firm expects the regulator to tighten the allocation factor after observing its clean technology investment, the firms' incentives to invest are moderated. If strong, this last negative effect may dominate the former positive effect on investments. Finally, if allowances are given only to a subset of firms or sectors, then other firms regulated by the ETS will increase their technology investments if and only if their total emission payments increase.
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