Resource information
This paper analyzes the dynamic effects
of rate-of-return regulation on firms’ emissions compliance
behavior when the price of emissions permits is uncertain.
The paper shows that uncertainty regarding the price of
permits would motivate a regulated firm to adopt a more
self-sufficient strategy and would reduce the
cost-effectiveness of emission allowance trading. When
allowance transactions are treated as capital investments,
uncertainty could reverse the classic Averch-Johnson effect,
so that a regulated firm would purchase fewer permits in the
ex ante period than its unregulated counterpart. These
results are driven by the asymmetric impact of a price
change on the expected marginal value of allowances under
rate-of-return regulation. A wider variation in the permit
price and a decline in the regulated rate of return would
amplify the asymmetry. These results have implications for
the efficiency of the proposed global carbon trading system.
