Carbon Markets in China: Strategic Interactions and Corporate Adaptation

Examining a cross section of seven regional Emission Trading System (ETS) and the national ETS in China, we explore the interplay between firms and governments. We find heterogeneous adaptation among firms. Firms in regions anticipating stringent policies reduce emissions and invest in decarbonization technology, whereas expectations of leniency lead to increased emissions. Meanwhile, governments set up more stringent carbon policies when firms decarbonize more proactively. The results are robust to allowance allocation policies, such as cap-and-trade or tradable performance standards. Our findings underscore the importance of strategic interactions between firms and governments in decarbonization.