National Climate Policies and Corporate Internal Carbon Pricing.

• Author: Bento, Nuno

1. INTRODUCTION

   The adoption of carbon pricing instruments has increased significantly in recent years. The World Bank (2018) estimates that countries representing more than one-half of global greenhouse gas emissions plan to use or will consider carbon pricing as at least one approach to implement their nationally determined contributions under the 2015 Paris Agreement. To deliver on the longterm goals of the Paris Agreement, more countries and more ambitious domestic programs will be necessary (Aldy et al., 2016; du Pont, 2017; Chyong et al., 2020). Carbon pricing policies create strong, transparent incentives to firms to internalize the social costs of carbon emissions (Popp et al., 2010; Kolstad et al., 2014; Nordhaus, 2014; Weitzman, 2015). In addition, major investors, along with financial regulators, are increasingly calling on companies to disclose their risks under climate change and policies intended to mitigate greenhouse gas emissions (Guardian, 2019).

   An increasing number of companies around the world has adopted internal carbon pricing (ICP), also referred to as "shadow carbon pricing" or "internal carbon tax pricing". ICP is a method for companies to internalize the implicit (actual or expected) cost of carbon. According to the large database collected by the Carbon Disclosure Project (CDP, 2017), over 600 companies in the world, with a market capitalization of US$15 trillion, already used ICP by 2017.

   Companies adopt internal carbon prices in various settings and for multiple reasons: to manage the regulatory and financial risks attached to the implementation of climate policies; to guide strategic planning activities as carbon pricing informs the long-term business model; to factor carbon prices into the decisions about capital investments (I4CE, 2016; CDP, 2016; Aldy and Gianfrate 2019; Bento and Gianfrate, 2020). Hence companies use internal carbon prices as an input into scenario planning, forecasting, sensitivity analyses, and investment net present value evaluations (WBCSD, 2015). Internal carbon prices may also serve to signal to the government that additional regulatory action is unnecessary, as well as represent a form of "greenwashing", i.e. opportunistic communication to persuade stakeholders that firms are delivering environmental improvements when in practice they are not undertaking meaningful changes (Kim and Lyon, 2011).

   The goal of this study is to investigate how firms respond to the implementation of a national carbon-pricing regime with respect to the carbon prices they set internally for their decision-making. We empirically investigate the adoption of internal carbon pricing by major companies reporting to the Carbon Disclosure Project. A matching estimator enables an appraisement of the effect that climate change policies have in the decision of companies to set their internal carbon prices. We find a causal relationship between the national carbon policies in place and the level of internal carbon prices. The treatment effect of having a national carbon pricing policy in place is economically (27 USD per ton) and statistically significant.

   The paper is structured as follows. Section 2 describes firm adoption of internal carbon prices and places this decision in the framework of government carbon pricing policies. Section 3 explains the research strategy to deal with the problem of endogeneity for the study of the firms' responses to a national carbon pricing with respect to setting their own carbon prices, as well as presents the variables, dataset and descriptive statistics. Section 4 analyzes the effect of the existence of a national carbon pricing and the impact of different carbon price levels. Finally, Section 5 concludes with the main findings and raises some questions for further research.

2. THE ADOPTION OF INTERNAL CARBON PRICES

   The cost of carbon effectively faced by companies is often complex, combining price and non-price regulations in different sectors (De Gouvello et al., 2020; Newbery et al., 2019; Stiglitz, 2019). Large discrepancies exist between carbon prices that are explicitly defined by carbon taxes or emissions trading systems, and prices that are implicitly derived from the application of other regulations. Explicit carbon prices were found to vary on the same fuels across different uses, within the same country (OECD, 2013b). For example, the OECD (2016) estimated the average effective carbon prices--encompassing both "explicit" emission permit price and carbon tax as well as more "implicit" taxes on energy use--for 41 countries at 14 $/tCO2. The effective carbon price differs significantly between transportation energy--with an average of $74/tCO2 covering 98% of emissions in this sector--and non-transport energy--with an average of $13/tCO2 covering 30% of these sectors.

   Table 1 presents data on explicit carbon prices, implicit carbon prices and effective carbon prices for several countries. It shows a high dispersion across countries and sectors. Effective carbon prices are clearly higher than explicit carbon prices driven by implicit carbon prices in road transport, households and electricity generation. Aligning climate and energy price and non-price regulation (e.g. standards, innovation support) is important for a long-term strategy on climate mitigation that can pave the way to the emergence of a carbon pricing in society (De Gouvello et al., 2020; Finon, 2019; Stiglitz, 2019), and companies may anticipate a future stringent carbon policy.

   Firms tend to react differently to carbon policy complexity (Chen et al., 2018). Studies show that there is heterogeneity in firm strategies concerning climate change issues (Backman et al., 2017; Pinkse and Kolk, 2010; Okereke, 2007). Electricity producers, for example, change their decisions depending on the institutional context, firm size and emissions (Weinhofer and Hofmann, 2010). In addition, large firms respond differently to policy uncertainty involving carbon taxes (Backman et al., 2017). The greater uncertainty over carbon prices under cap-and-trade programs relative to carbon tax systems may also influence firm expectations and investment behavior (Aldy and Armitage, 2020). However, low carbon prices have generally provided weak signals for firms to reduce their emissions.

   Firms' incentives to take climate action also depend on other factors than the current level of carbon prices. Companies with long lasting assets can be more vulnerable to increases in the carbon price than other companies with short lifecycle assets. This is particularly the case of heavy industries (e.g. steel, cement) or energy companies (e.g. oil and gas, electricity utilities). These companies may be more willing to implement internal carbon prices that are higher than explicit carbon prices (carbon taxes or prices issued from trading systems), independent of currently low carbon taxes. Thus, internal carbon pricing allows investors to assess the extent to which companies (especially from high-polluting sectors) take measures in order to reduce their vulnerability to increasing carbon costs.

   Large corporations have publicly disclosed their internal carbon prices through the Carbon Disclosure Project (CDP), which is a global initiative that surveys the carbon strategies of large companies. The CDP initiative started in 2002 at the request of 35 institutional investors managing more than $4.5 trillion of assets because of the growing need...