From free to fee : how emission permit allocation affects firms

This study provides new causal evidence on the firm-level effects of reducing free emission permits in emission trading systems. Using a difference-in-differences design, we exploit a reform that altered an eligibility threshold for free permit al- location. Receiving fewer free permits reduced emissions by more than 14 percent relative to firms that retained them. This reduction was accompanied by similar declines in revenue, employment, and assets. We develop a multi-product general equilibrium model that explains these patterns through a novel mechanism linking permit allocation to firms’ decisions. Firms that receive fewer free emission permits terminate their least productive product lines, increasing the market share of the remaining ones. Higher expected profits then encourage earlier adoption of an efficiency-improving technology.