Market-based emissions regulation and capacity governance in China’s high-carbon firms: Theoretical investigation and empirical evidence

Despite extensive research, it remains unclear whether China’s market-based emission regulation can effectively curb overcapacity in incumbent high-carbon firms, given the inherent complexity of the scheme. By adopting a carbon market perspective, this study theoretically clarifies the mechanism through which the market-based emission regulation affects the firm’s production capacity utilization within a partial equilibrium framework. In addition, we empirically assess China’s emissions trading system (ETS) policy using the double machine learning approach and China’s firm-level data from 2008 to 2022. The results demonstrate that China’s ETS policy significantly enhances the capacity utilization of the high-carbon firms in pilot regions. Furthermore, we show that this market-based emissions regulation primarily addresses overcapacity by increasing compliance costs, fostering technical innovation, discouraging over-investment, and optimizing resources allocation. The policy effect is more pronounced in regions with stringent regulations on allowances allocation and robust market supervision. Therefore, ETS policymakers should strengthen regulations related to emissions cap setting and compliance behavior supervision to accelerate the phase out of outdated capacities in high-carbon firms.