Moral Hazard and the Market-Based Method: Does Using Renewable Energy Attributes in Emissions Reporting Affect Corporate Emissions Performance?

Abstract

An increasingly widespread accounting practice for electricity (scope 2) emissions, known as the ‘market-based method’, is problematic as it allows companies to use purchased renewable energy attributes (REAs) to report lower emissions, which therefore no longer reflect the actual location-based electricity generation emissions resulting from the company's electricity consumption. Using REAs therefore may create a moral hazard, as companies using these arrangements are insulated from the consequences of their actions and may thus have less incentive to genuinely reduce their emissions. We construct a year-on-year matched sample of firms using/not using REAs (2,716 firms with 12,700 firm-year observations from 2006 to 2018) and apply a two-way fixed effects difference-in-difference (DiD) method to investigate the effects of REA use on emissions performance. We find that firms using REAs increase their absolute energy consumption and absolute emissions (scope 1 and 2) relative to companies that do not use REAs, while simultaneously reducing their relative emissions intensities per unit revenue, and that all effects are more significant after three or more years of REA use. The observed intensity reductions do not indicate genuine improved emissions performance, however, as firms using REAs do not improve their energy efficiency, but instead have higher revenue and tend to be located in countries with lower location-based grid emission factors. We conclude that companies, investors, and customers should beware the potential for moral hazard arising from the use of the market-based method, and should ensure that renewable energy purchasing drives additional renewable supply and does not distract firms from taking genuine mitigation actions.