Market responses to global governance: International climate cooperation and Europe's carbon trading

Abstract

AbstractInternational environmental cooperation can impose significant costs on private firms. Yet, in recent years some companies have been supportive of international climate agreements. This suggests that under certain conditions environmental accords can be profitable. In this paper, I seek to explain this puzzle by focusing on the interaction between domestic regulation and decisions at international climate negotiations. I argue that global climate cooperation hurts the profits of polluting firms if domestic governments do not shield them from international compliance costs. Vice versa, if firms are subject to protective (i.e., insufficiently severe) policy instruments at home, firms can materially gain from international climate agreements that sustain expectations about their profitability. I test the argument with an event study of the effect of decisions at the UN Framework Convention on Climate Change (UNFCCC) on major European firms that received free carbon permits in the early stages of the European Union Emission Trading Scheme (EU ETS). The analysis suggests that financial markets carefully follow the international climate negotiations, and reward the regulated firms based on the outcome of UNFCCC decisions. The evidence also indicates the advantageous interplay between certain types of domestic regulations and international regimes for business. More generally, the results show the perils of privately supported policy for the effectiveness of international public good provision.