Voluntary Agreements with Industries: Participation Incentives with Industry-wide Targets

There is an increasing interest in the use of voluntary approaches to environmental protection as an alternative to more traditional regulatory approaches. In many cases, entire industries are faced with possible imposition of costly environmental policies if environmental goals are not met voluntarily. If the threat is industry-wide, a potential free-rider problem exists since, if the environmental goal is met by others, individual firms would benefit from avoidance of the costly policy without incurring the associated cost. We develop a multiple-firm model of an industry's voluntary adoption of environmental protection measures to achieve a predetermined industry-wide emissions reduction target under an explicit threat of imposition of an emissions tax. We examine the free-riding incentive of individual firms and its impact on the viability of a voluntary approach to pollution control (VA). We find that despite the free-riding problem, there is an incentive for a sub-group of firms in an industry to participate in a VA. A VA is strictly preferred by the industry as a whole (aggregate industry profits are higher), although it is cost inefficient from society's point of view.