Environmental investment timing and dual government incentives under uncertain carbon allowances

Abstract

The government's post compliance cycle announcement of carbon allowances hampers firms from obtaining accurate information. Firms must estimate carbon allowances before determining the optimal environmental investment timing. Typically, firms prioritize environmental investments by introducing environmental equipment during the compliance cycle (ID) when their estimated carbon allowances are low. Conversely, they prefer to make environmental investments after the compliance cycle (IA) by purchasing carbon credits to offset excess emissions. This study aims to present a process and outcomes for firms to accurately select the timing of environmental investments based on estimated carbon allowances. Moreover, their improper timing can lead to a loss in government social welfare. To mitigate the loss, the dual government incentives of commitment and subsidies are further introduced. Contrary to the intuition that low carbon estimates would lead to an ID decision, firms should choose IA due to the higher costs and shorter lifespan for introducing environmental equipment or lower carbon prices. Generally, the government sets the least strict carbon allowances that still achieve the desired incentives while staying within the permissible spectrum of environmental preservation. However, for firms that face high market demand but experience reduced production due to technological or cost constraints, the government should provide subsidies to encourage them to adopt alternative investment timing. This will ensure product supply, maintain firm profits, and enhance social welfare.