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ESSEYS ON THE DESIGN AND ENFORCEMENT OF MARKET-BASED ENVIRONMENTAL POLICIES

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Title: ESSEYS ON THE DESIGN AND ENFORCEMENT OF MARKET-BASED ENVIRONMENTAL POLICIES
Author: Oestreich, Andreas Marcel
Department: Department of Economics
Program: Economics
Advisor: Livernois, John
Abstract: Environmental degradation is one of the key challenges of our times. Economists see the problem of environmental degradation as one in which economic agents impose negative environmental externalities upon society in the form of pollution. Market-based environmental policy instruments, such as taxes or tradable permits intend to provide incentives for polluters to reduce negative environmental externalities. They seek to incorporate the external cost of production through taxes or by creating property rights and facilitating the establishment of a market for the use of environmental services. This Thesis studies the design and enforcement of market-based environmental policies from a theoretical and empirical perspective. The special focus is thereby on the often overlooked strategic interactions and the information asymmetry between the designer of an environmental regulation and the regulated agents. For instance, when designing an emissions tax system, regulatory authorities may require polluters to self-report on their level of pollution, because especially in the case of non-point emissions, it is not observable to the regulator directly which firm polluted how much. Furthermore, when designing an emissions trading scheme, regulatory authorities may require information about how many tradable permits should be allocated free of charge during the initial allocation to offset potential losses to the industry. In both examples, the incentives of the designer of the regulation and the regulated agents are not aligned. In case of an emission tax, agents might underreport their emissions to save on tax payments. Of course, it is common practice to audit some fraction of reports and to impose penalties when underreporting is discovered. However, penalties are limited and auditing is costly for the regulator and therefore the detection probability is determined by its operating budget, which may be tight. In case of an emissions trading system, firms may demand higher amounts of free permits than actually necessary to offset any losses, which might not be easily verifiable by the regulator either. The first chapter is entitled "Firms’ Emissions and Self-reporting under Competitive Audit Mechanisms''. It focuses on the restricted audit capacity of environmental regulatory authorities to verify whether or not firms are in compliance with environmental policies. I introduce a novel type of audit mechanism that induces more truthful reporting and lower emission levels by firms in comparison to the commonly applied audit mechanism. The second chapter is entitled "On Optimal Audit Mechanisms'' and builds on the analysis in the first chapter. I derive an audit mechanism that leads to socially optimal emissions while the commonly used audit mechanism in the literature fails to achieve this first-best emissions levels given the same audit resources of the regulator. The third chapter is entitled "Carbon Emissions and Stock Returns – Evidence from the EU Emissions Trading Scheme''. I jointly worked on this chapter with Professor Ilias Tsiakas. We investigate the effect of the European Union Emissions Trading Scheme (EU ETS) on the profits of firms as reflected by their stock returns. Despite facing the burden of a new regulation, portfolios of firms which were directly affected by the EU ETS significantly outperformed portfolios of firms which were not directly affected. We provide evidence that this is due to the subsidy-like effect of substantial free carbon certificate allocations from European Governments to the affected firms. Our new result informs the environmental policy debate in North America and elsewhere, as the EU ETS is seen as the prototype for a potential global climate policy regime that would be based on emissions trading.
URI: http://hdl.handle.net/10214/7701
Date: 2013-12
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