Exit Incentives for Carbon Emissive Firms

TL;DR

This paper models the incentives for carbon-emitting firms to exit markets using a continuous-time stochastic framework, analyzing the effects of regulation, market concentration, and international coordination on exit timing and compensation payments.

Contribution

It introduces a novel continuous-time model for firm exit incentives with explicit solutions for compensation and exit thresholds, including multi-country extensions and equilibrium analysis.

Findings

Market concentration reduces total expected payments and exit times.

Second mover advantage can lead to multiple equilibria in international regulation.

Large countries are unlikely to coordinate on exit timing.

Abstract

We develop a continuous-time model of incentives for carbon emissive firms to exit the market based on a compensation payment identical to all firms. In our model, firms enjoy profits from production modeled as a simple geometric Brownian motion and do not bear any environmental damage from production. A regulator maximises the expected discounted value of firms profits from production minus environmental damages caused by production and proposes a compensation payment whose dynamics is known to the firms. We provide in both situations closed-form expressions for the compensation payment process and the exit thresholds of each firms. We apply our model to the crude oil market. We show that market concentration both reduces the total expected discounted payment to firms and the expected closing time of polluting assets. We extend this framework to the case of two countries each regulating its own market. The presence of a second mover advantage leads to the possibility of multiple equilibria. Applying this result to large producing countries, we find that they are unlikely to agree on the timing to exit market.