Reporting Bias and Monitoring in Clean Development Mechanism Projects*

Hui Chen,Naomi Soderstrom,Peter Letmathe

doi:10.1111/1911-3846.12609

Abstract

ABSTRACTThe Clean Development Mechanism (CDM) is a flexible carbon market mechanism managed by the United Nations. The program grants tradable carbon emissions credits (Certified Emission Reductions) for carbon‐reducing projects in developing countries. A project can only be admitted to the program if it is not financially profitable, and thus would not take place without the emission credits granted through the CDM. In this paper, we examine how monitoring reduces incentives of companies to bias the reported expected financial viability of potential CDM projects to gain admission to the program. We find that reported rates of return, which are a key factor for admission to the program, tend to be downwardly biased and are negatively associated with the expected benefits stemming from forecasted greenhouse gas reductions. However, monitoring from various sources mitigates some of the distorted incentives and related reporting bias. Furthermore, the monitoring effect becomes much stronger after 2008, when the CDM Executive Board implemented a series of measures to strengthen the additionality testing that provides guidance for program applications.

Highlights

IntroductionThe Clean Development Mechanism (CDM) is one of the flexible mechanisms available under the Kyoto Protocol (United Nations 1998). If CDM projects are approved, host firms can earn Certified Emission Reductions (CERs), each of which is equivalent to the reduction of one metric ton of CO2 and can be used to satisfy obligations stemming from the Kyoto Protocol and European Union regulations
If Clean Development Mechanism (CDM) projects are approved, host firms can earn Certified Emission Reductions (CERs), each of which is equivalent to the reduction of one metric ton of CO2 and can be used to satisfy obligations stemming from the Kyoto Protocol and European Union regulations
The most important criterion for a project to be approved by the CDM Executive Board (EB), is that the project would not have taken place without the economic incentives provided by CDM

Summary

Introduction

The Clean Development Mechanism (CDM) is one of the flexible mechanisms available under the Kyoto Protocol (United Nations 1998). If CDM projects are approved, host firms can earn Certified Emission Reductions (CERs), each of which is equivalent to the reduction of one metric ton of CO2 and can be used to satisfy obligations stemming from the Kyoto Protocol and European Union regulations. If CDM projects are approved, host firms can earn Certified Emission Reductions (CERs), each of which is equivalent to the reduction of one metric ton of CO2 and can be used to satisfy obligations stemming from the Kyoto Protocol and European Union regulations. We focus on the method of investment analysis, which requires the project’s estimated return on investment to be lower than a reasonable benchmark rate. The requirement gives project host firms strong incentives to underreport estimated project returns to be below the benchmark rate. In addition to empirically examining the incentive for understating the project’s forecasted internal rate of return (IRR) in order to qualify for UN approval, we investigate how monitoring mechanisms at both the country- and the project-level can mitigate the incentive

Methods

Results

Conclusion