To divide or not to divide: Impact of carbon market connections on firms’ resilient profitability and emission reduction.

Abstract

The lack of harmonized carbon regulations across regions poses a significant obstacle to achieving effective carbon emission reduction, thereby underscoring the necessity for interregional carbon market connections. By employing a game-theoretical optimization model, this study examines the impact of independent and connected carbon regulations on the performance of a multinational firm (MNF) operating in different countries. Interestingly, we show that the MNF with either low or high emission intensity can benefit from higher carbon trading prices when provided with a small emission quota in independent carbon markets. A higher price can increase carbon trading profits without significantly impacting product sales for the MNF with low emission intensity. Conversely, the MNF with high emission intensity faces a higher emission cost and must be compensated by a higher transfer price, adversely affecting product sales. However, the potentially lowered emission cost, coupled with significant carbon trading profit, can mitigate the negative effects for the MNF. We further show that the MNF's preference for connected carbon markets depends on carbon trading prices, emission intensity, and quotas. When the unified carbon trading price is high, the MNF prefers connected markets when emission intensity is low or high, but not in the moderate range. A high unified price benefits the MNF with low emission intensity, while the combination of emission quotas benefits the MNF with high emission intensity in managing excessive emissions. As the unified carbon trading price decreases, the MNF's preference for connected markets changes. Only the MNF with moderate emission intensity displays a preference for connected markets when faced with a high domestic emission quota.