Can Capital Markets Create Incentives for Pollution Control?
28 Pages Posted: 20 Apr 2016
Date Written: March 1997
Private firms reluctant to invest in pollution abatement when the penalty for noncompliance falls short of the cost of abatement may be more willing to invest in pollution abatement when enforcement is tougher or when information is released that allows capital markets to react to ranking of firms in terms of their environmental performance.
After weighing the costs and benefits of pollution control, profit-maximizing firms sometimes choose not to invest in pollution abatement because the penalty they expect regulators to impose for noncompliance falls short of the cost of abatement. To improve incentives for pollution control, regulators have recently embarked on a strategy to release information to communities and markets (investors and consumers) about firms' environmental performance.
Drawing on evidence from American and Canadian studies, Lanoie, Laplante, and Roy report that capital markets do react to the release of such information. The evidence suggests that heavy polluters are affected more significantly than minor polluters. And firms whose market values are hurt most by the release of this information are most likely to invest in pollution abatement.
The firms' greater willingness to invest in pollution abatement seems to result from the regulators' willingness to undertake strong enforcement actions combined with the possibility of capital markets reacting to public ranking of firms in terms of their environmental performance. This paper - a product of the Environment, Infrastructure, and Agriculture Division, Policy Research Department - is part of a larger effort in the department's ongoing work on industrial pollution and also to study whether capital markets in developing countries can provide the incentives needed for pollution control. The study was funded by the Bank's Research Support Budget under the research project Incentives for Pollution Control in Developing Countries: The Role of Capital Markets (RPO 680-76).
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