Energy price uncertainty, environmental policy, and firm investment: A dynamic modeling approach

Abstract

Environmental quality is closely related to the production and investment behavior of enterprises, which depends on the discounted future cash flows that are affected by energy price uncertainty. Meanwhile, with the increasing awareness of environmental protection, environmental policies have been introduced to restrict firm investment choices. However, the role of environmental policy has received less attention in the previous research on energy prices and firm investment. Therefore, this paper develops a dynamic firm investment model that incorporates energy price uncertainty and environmental regulation and makes the following predictions. First, ceteris paribus, energy price uncertainty negatively impacts firm investment. Second, environmental regulations mitigate this negative impact of energy price uncertainty. Third, the mitigating effect of environmental policy is greater in pollution-intensive industries. This paper merges the micro-data on A-share listed firms in China between 2004 and 2018 with the macro-data on energy prices and environmental regulation. The empirical results align with the theoretical predictions. The robustness tests, including instrumental variables, alternative measurements, and estimation methods, validate the baseline findings. These theoretical and empirical findings yield important implications for policymakers.