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HomePaperOpening the Brown Box: Production Responses to Environmental Regulation

Opening the Brown Box: Production Responses to Environmental Regulation

1 January 2024
Authors: Rebecca De Simone (London Business School), Lakshmi Naaraayanan (London Business School) and Kunal Sachdeva (Graduate School of Business, Rice University)

We study production responses to emission capping regulation on manufacturing firms. We find that firms reduced their pollution as they transitioned from self-generated to externally sourced electricity, shifted toward producing less coal-intensive products, and increased their abatement expenditures. Firms preserved profitability by increasing their production of higher-margin products. However, firms in highly polluting industries produced fewer products. In the aggregate, we document lower product variety, higher markups, an altered firm-size distribution, and lower business formation. Our findings highlight both the mechanisms behind how mandated pollution reduction can be effective and its costs, suggesting a loss in agglomeration externalities.

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