Environmental Standards: Government Strategies for Setting Deadlines

Abstract

The acceleration of global warming has forced governments to further monitor and regulate the greenhouse gas emissions of industry. One of the simplest and most common approaches that governments use to reduce firms' emissions is to set an environmental standard for firms to comply with before a specific deadline. In this study, we examine how a government should set the deadline for a new standard in a market with two competing firms, both of whom make technology development and production decisions. Our work takes the perspective of the government and emphasizes the timing of her decision, a critical and yet understudied dimension in the literature. We find that, in general, when setting the deadline, the government should focus on how the firms are differentiated. Specifically, when the environmental impact of firms' noncompliance is high, the government should focus on potential differences in the firms' production abilities and leverage the effect of market competition to set an earlier deadline. When instead, the impact is low, the government should focus on whether differences exist between the firms' development capabilities and set a deadline such that all firms comply on time. Extending our base model, we find that (i) a government assistance program can be an effective complementary lever (to a deadline) for decreasing firms' compliance times and costs, and (ii) to ensure compliance, the government should almost always set the deadline in a way to promote collaboration amongst firms.