Do carbon markets induce suppliers’ green innovation through backward linkages?

Carbon Emissions Trading Schemes (ETSs) aim to incentivize firms’ abatement efforts by pricing carbon emissions. However, regulated firms may transfer abatement pressure upstream, as their emissions partly depend on input materials. This study examines the ETS’s impact on suppliers’ green innovation by combining propensity score matching and staggered difference-in-differences. Taking China’s pilot ETSs as a quasi-natural experiment, the empirical results show that ETS-regulated firms have incentivized unregulated suppliers’ green innovation through knowledge spillover, innovation requirements, and cost-sharing. The increase in green patents primarily results from collaborative innovation efforts instead of opportunistic behavior. However, suppliers’ innovative efforts underperform in low-carbon domains and crowd out non-green innovations. Moreover, the ETS’s influence is more evident for pilot programs with a stabilizing mechanism, suppliers serving regulated customers in high-carbon sectors, or suppliers with greater innovation willingness and capability. Overall, this study offers new insights into regulated firms’ strategic choices, thus providing implications for policymakers to enhance the ETS’s effectiveness.