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Stock Prices and the Cost of Environmental Regulation

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  • Linn, Joshua

Abstract

In an attempt to reduce compliance costs and improve efficiency, recent environmental regulations have relied on market-based incentives. In most cases, the Environmental Protection Agency (EPA) selects an emissions cap and allows firms to trade pollution permits. The EPA typically selects the cap using a "bottom-up" approach to predict the costs of such regulations, forecasting how every affected firm will respond to the program. It is uncertain whether firms rely on the same predictions in making their compliance decisions; discrepancies between the actual and expected behavior of the affected firms could reduce the cost-effectiveness of the program. This paper uses stock prices to compare the predictions of the bottom-up studies with those of the affected firms.I focus on a recent tradable permit program, the Nitrogen Oxides Budget Trading Program (NBP). Started in 2004, the NBP requires electric generators in the Midwest and East to reduce their emissions or purchase permits from other firms. I compare utilities' stock prices with the prices that would have occurred in the absence of the new regulation. I make this comparison by exploiting variation in the location of generators owned by utilities; the control group consists of utilities without any generators in the NBP. I estimate that investors expected the program to reduce profits by about $2 billion per year (2000 dollars). Investors expected the NBP to primarily affect coal generators, which have larger baseline emission rates than other fossil fuel generators. These results agree with previous studies that used the bottom-up approach.

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Bibliographic Info

Paper provided by Regulation2point0 in its series Working paper with number 329.

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Date of creation: Jun 2006
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Handle: RePEc:reg:wpaper:329

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  1. Curtis Carlson & Dallas Burtraw & Maureen Cropper & Karen L. Palmer, 2000. "Sulfur Dioxide Control by Electric Utilities: What Are the Gains from Trade?," Journal of Political Economy, University of Chicago Press, vol. 108(6), pages 1292-1326, December.
  2. Krupnick, Alan & McConnell, Virginia & Stoessell, Terrell & Cannon, Matthew & Batz, Michael, 2000. "Cost-Effective NOx Control in the Eastern United States," Discussion Papers dp-00-18, Resources For the Future.
  3. Burtraw, Dallas & Palmer, Karen & Krupnick, Alan & Evans, David & Toth, Russell, 2005. "Economics of Pollution Trading for SO2 and NOx," Discussion Papers dp-05-05, Resources For the Future.
  4. Salinger, Michael, 1992. "Standard Errors in Event Studies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 27(01), pages 39-53, March.
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Cited by:
  1. Veith, Stefan & Werner, Jörg R. & Zimmermann, Jochen, 2009. "Capital market response to emission rights returns: Evidence from the European power sector," Energy Economics, Elsevier, vol. 31(4), pages 605-613, July.
  2. Managi, Shunsuke & Okimoto, Tatsuyoshi, 2013. "Does the price of oil interact with clean energy prices in the stock market?," Japan and the World Economy, Elsevier, vol. 27(C), pages 1-9.
  3. Fabio Iraldo & Francesco Testa & Vlasis Oikonomou & Michela Melis & Marco Frey & Eise Spijker, 2009. "A literature review on the links between environmental regulation and competitiveness," Working Papers 200904, Scuola Superiore Sant'Anna of Pisa, Istituto di Management.

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