On the Link between Environmental and Market Performance under Market-Based Environmental Regulation

Abstract

We empirically study the link between firms' environmental performance and market performance under market-based regulation based on permits for emissions. A popular view is that environmentally beneficial investments more than pay for themselves through improved efficiency, reduced compliance costs, and favorable market perception. A differing view is that environmental investments are limited in their economic benefit and could therefore erode shareholder value. Along the lines of the latter view and given the typical costs of engaging in environmental compliance activities, we hypothesize that the market would penalize cleaner firms when the regulatory program offers the opportunity to cost-effectively choose a compliance strategy and, additionally, cushions firms from compliance costs by employing policy concessions such as grandfathering. Data from the US Acid Rain Program supports our hypothesis.