investment based financing constraints and debt renegotiation we consider how equity holders bargaining power during financial distress influences the interactions between financing and investment decisions when the firm faces the upper limit of debt issuance we obtain four results first weaker equity holders bargaining power is more likely that the firm is financially constrained second the investment quantity is independent of equity holders bargaining power third the constrained credit spreads are increasing with equity holders bargaining power contrary to the unconstrained ones fourth higher volatility and weaker equity holders bargaining power are likely that the firm prefers to issue debt with renegotiation compared with debt without renegotiation c 2014 elsevier b v all rights reserved

policy spillovers in the regulation of multiple pollutants abstract we analyze the interplay between policies aimed to control transboundary and local pollutants such as greenhouse gases and particulate matter the two types of pollution interact in the abatement cost function of the polluting firms through economies or diseconomies of scope they are regulated by distinct entities potentially with different instruments that are designed according to some specific agenda we show that the choice of regulatory instrument and the timing of the regulations matter for efficiency emissions of the local pollutant are distorted if the regulators anticipate that transboundary pollution will later be regulated through emission caps the regulation is too stringent with diseconomies of scope and not enough with economies of scope in contrast we obtain efficiency if the transboundary pollutant is regulated by emission taxes or tradable emission permits provided that the revenue from taxing emissions are redistributed to the countries in a lump sum way and that the initial allocation of tradable emission permits is not linked to abatement costs

a theory of corporate financial decisions with liquidity and solvency concerns this paper studies the impact of both liquidity and solvency concerns on corporate finance i present a tractable model of a firm that optimally chooses capital structure cash holdings dividends and default while facing cash flows with long term uncertainty and short term liquidity shocks the model explains how changes in solvency affect liquidity and also how liquidity concerns affect solvency via capital structure choice these interactions result in a dynamic cash policy in which cash reserves increase in profitability and are positively correlated with cash flows the optimal dividend distributions implied by the model are smoothed relative to cash flows i also find that liquidity concerns lead to a decrease of dispersion of credit spreads

trading for the future signaling in permit markets abstract permit markets are celebrated as a policy instrument since they allow i firms to equalize marginal costs through trade and ii the regulator to distribute the burden in a politically desirable way these two concerns however may conflict in a dynamic setting anticipating the regulator s future desire to give more permits to firms that appear to need them firms purchase permits to signal their need this raises the price above marginal costs and the market becomes inefficient if the social cost of pollution is high and the government intervenes frequently in the market the distortions are greater than the gains from trade and non tradable permits are better the analysis helps to understand permit markets and how they should be designed

implementing marketable emissions permits the environmental protection agency is introducing bubbles offsets and banks as a way of controlling pollution with market incentives to obtain standards for each source and guide the reallocation of emissions the new method is not a true market because polluters must go through the permitting procedure in order to trade emission allowances this study examines whether an efficient market without source by source review is feasible it considers the importance of enough participants competitiveness sensitivity to geographic emission patterns and trading flexibility to sustain marketable permits the design features that address these problems are permit life market definition market initiation and market operation a stable permit market eliminates some of the uncertainties in decision making because it allows firms to select a preferred level of risk 9 references dck

planning under incomplete information and the ratchet effect abstract central planning of production is usually performed under asymmetric information the firm in general has more information about its productive possibilities than the central planner from now on for short cp this justifies the use of incentives schemes in which the cp does not directly fix activity levels casual observation of such existing schemes suggests that the time dimensions is crucial for their working typically the cp revises the incentive scheme over time to take into account the information provided by the firm s performance managers of centrally planned economies as well as economists have long recognized that this revision induces firms to underproduce in order to avoid demanding schemes in the future this is the ratchet effect it is purpose of the present paper to study the ratchet effect under the non commitment assumption which we believe to be more realistic the inadequacy of conceptual tools made if difficult in the past to consider such an assumption now basic research on dynamic games with incomplete information recently resulted in new ideas which look particularly relevant for a theoretical analysis of the problem

sulfur dioxide control by electric utilities what are the gains from trade title iv of the 1990 clean air act amendments caaa established a market for transferable sulfur dioxide so2 emission allowances among electric utilities this market offers firms facing high marginal abatement costs the opportunity to purchase the right to emit so2 from firms with lower costs and this is expected to yield cost savings compared to a command and control approach to environmental regulation this paper uses econometrically estimated marginal abatement cost functions for power plants affected by title iv of the caaa to evaluate the performance of the so2 allowance market specifically we investigate whether the much heralded fall in the cost of abating so2 compared to original estimates can be attributed to allowance trading we demonstrate that for plants that use low sulfur coal to reduce so2 emissions technical change and the fall in prices of low sulfur coal have lowered marginal abatement cost curves by over 50 percent since 1985 the flexibility to take advantage of these chan

market power in emission permit markets theory and evidence from the eu ets a well known result about market power in emission permit markets is that efficiency can be achieved by full free allocation to the dominant firm i show that this result breaks down when taking the interaction between input and output markets into account even if the dominant firm perceives market power in the permit market alone i then examine the empirical evidence for price manipulation by the ten largest electricity firms during phase i of the eu ets i find that some firms excess allowance holdings are consistent with strategic price manipulation and that they cannot be explained by price speculation or by precautionary purchases to insure against uncertain future emissions my results suggest that market power is likely to be an empirically relevant concern during the early years of emission permit markets

benchmarking in the european union emissions trading system abatement incentives abstract this paper investigates abatement incentives for allowance allocation based on output and sector specific benchmarks here called output based allocation or benchmarking special attention is given to updated allocation and we assume that allowances can be traded with other sectors open cap we confirm earlier studies that output based allocation based on ex ante data provide the same abatement incentives as auction or grandfathering and also confirm that output based allocation with updated output and ex ante benchmarks provides as high abatement incentives as auction but constitutes a production subsidy however we also find that benchmarking with updated output and updated benchmarks reduces abatement incentives somewhat but less so than updated grandfathering an allocation rule where the sector cap is prescribed ex ante for instance based on historic emissions and distributed to installations in proportion to their updated production preserves full abatement incentives and avoids some of the costs associated with the determination of benchmarks however this rule also constitutes a production subsidy which decreases with industry concentration if a sector is split into smaller groups each with one benchmark per sub sector benchmarking evolves toward grandfathering since benchmarking is conditioned on production this allocation method protects production from leakage i e migrating to areas where firms face no emissions cost this may actually be the most compelling reason for choosing benchmarking

investment under uncertainty with strategic debt service the presence of a well designed bankruptcy code is an important part of the nancialarchitecture in developed economies by allowing the creditors to seize the assets of theborrowers who fail to make contractual payments the code generates bene cial ex ante e ectson debt capacity and rm value by giving the borrowers options to renegotiate their debtobligations and seek bankruptcy protection the code increases the likelihood that borrowersmay avoid ine cient ex post liquidation as hart 1999 notes the code should balanceex ante rm value maximization with ex post e ciency the bankruptcy codes in di erentcountries weight this tradeo di erently and hence vary in terms of the distribution of rightsand powers between borrowers and lenders in this paper we provide an inter temporal framework to examine how the creditors liquidation rights and the distribution of ex post bargaining powers in uence the rm s in vestment and nancing decisions and a ect ex ante rm value we show that strongerequityholders bargaining power lowers debt capacity reduces rm value and discouragesgrowth option exercising our calibration suggests that the quantitative e ects of ex poststrategic renegotiation on ex ante rm value may be large our paper provides an attempt to integrate nancial architecture into the theory of in vestment growth option exercising by building on two strands of literature investment anddebt pricing we extend the real options approach to investment pioneered by mcdonaldand siegel 1986 and brennan and schwartz 1985 to allow for capital structure decisionsunder strategic debt service we also draw insights from corporate debt pricing capital struc ture literature which focuses on leverage and security pricing after investment has alreadybeen made merton 1974 black and cox 1976 and leland 1994 our paper bridgesthe gap between these two strands of literature by characterizing the optimal investment and nancing decisions and the option value of waiting in closed form we show that the inter action between nancing and investment decisions in the presence of strategic debt servicegenerates new insights and also quantitatively important e ects on ex ante rm value

temporary versus permanent shocks explaining corporate financial policies we investigate corporate financial policies in the presence of both temporary and permanent shocks to firms cash flows in our framework cash flows can be negative and are imperfectly correlated with firm value and earnings volatility differs from asset volatility these results are consistent with empirical stylized facts they are also contrary to the implications of existing dynamic capital structure models that allow only for permanent shocks to cash flows temporary shocks increase the importance of financial flexibility and may provide an intuitively simple and realistic explanation of empirically observed financial conservatism and low leverage phenomena the theoretical framework developed in this article general enough to be used in various corporate finance applications jel g12 g32 g33

ex ante and ex post welfare optimality under uncertainty it is widely believed by economic theorists that if there were no transactions costs and if all information about the economy were perfectly shared by all then arrow debreu contingent commodity markets should bring about an ideal allocation the basis for this belief seems clear we have the two efficiency theorems of welfare economics which assure us that in the absence of external effects any competitive allocation is pareto efficient and that any pareto efficient allocation is competitive provided that appropriate lump sum transfers are made of course there are some reservations that need to be made local satiation and non convexities are well known to cause problems but these are not the problems i wish to discuss here to return to the usual argument the next step involves noticing how with contingent commodity markets the efficiency theorems of welfare economics carry over to an economy with uncertainty as explained for instance in chapter 7 of debreu s theorpj of value the fundamental value judgment that gives these efficiency theorems their normative interest is what may be called consumer sovereignty it is an assumption that the social welfare ordering should respect the preferences that govern consumers market behaviour it is a serious value judgment more serious than most economists have been prepared to concede but its seriousness increases when there is uncertainty we know full well that individuals misperceive the probabilities of certain events assuming that they even perceive any probabilities at all see for example kahneman and tversky 1979 nor are we always willing to accept as appropriate the attitudes to risk of individuals who seem either extremely reckless or extremely cautious societies are often willing to make some gestures towards property owners who have not insured themselves adequately against damage from fire flood or tempest and not just because of imperfect insurance markets or even misperceptions of probabilities in addition the inequalities of income that arise when some individuals take more risks than others are not necessarily seen to be desirable particularly if an individual has undertaken a useful but risky activity and has a very low income as a result of failure such gestures are examples of contingent lump sum transfers it seems clear that if such transfers occur to a sufficient extent they could supplant completely the securities markets which are usually sufficient to bring about pareto efficiency they may even be able to go further and correct the imperfections of an arrow debreu market allocation when individuals do misperceive probabilities or else have wrong attitudes to risk this is the main question i wish to consider here the idea that consumer sovereignty should not always extend to economies with uncertainty is not new it can be found in work by diamond 1967 dr6ze

evaluating natural resource investments notwithstanding impressive advances in the theory of finance over the past 2 decades practical procedures for capital budgeting have evolved only slowly the standard technique which has remained unchanged in essentials since it was originally proposed see dean 1951 bierman and smidt 1960 derives from a simple adaptation of the fisher 1907 model of valuation under certainty under this technique expected cash flows from an investment project are discounted at a rate deemed appropriate to their risk and the resulting present value is compared with the cost of the project this standard textbook technique reflects modern theoretical developments only insofar as estimates of the discount rate may be obtained from crude application of single period asset pricing theory but see brennan 1973 bogue and roll 1974 turnbull 1977 constantinides 1978 the inadequacy of this approach to capital budgeting is widely acknowledged although not widely discussed its obvious deficiency is its the evaluation of mining and other natural resource projects is made particularly difficult by the high degree of uncertainty attaching to output prices it is shown that the techniques of continuous time arbitrage and stochastic control theory may be used not only to value such projects but also to determine the optimal policies for developing managing and abandoning them the approach may be adapted to a wide variety of contexts outside the natural resource sector where uncertainty about future project revenues is a paramount concern

what can we learn from the grand policy experiment lessons from so2 allowance trading stable url http links jstor org sici sici 0895 3309 28199822 2912 3a3 3c69 3awcwlft 3e2 0 co 3b2 tthe journal of economic perspectives is currently published by american economic association your use of the jstor archive indicates your acceptance of jstor s terms and conditions of use available athttp www jstor org about terms html jstor s terms and conditions of use provides in part that unless you have obtainedprior permission you may not download an entire issue of a journal or multiple copies of articles and you may use content inthe jstor archive only for your personal non commercial use please contact the publisher regarding any further use of this work publisher contact information may be obtained athttp www jstor org journals aea html each copy of any part of a jstor transmission must contain the same copyright notice that appears on the screen or printedpage of such transmission the jstor archive is a trusted digital repository providing for long term preservation and access to leading academicjournals and scholarly literature from around the world the archive is supported by libraries scholarly societies publishers and foundations it is an initiative of jstor a not for profit organization with a mission to help the scholarly community takeadvantage of advances in technology for more information regarding jstor please contact support jstor org http www jstor orgtue jun 26 16 25 17 2007

an interim evaluation of sulfur dioxide emissions trading ide iv of the 1990 clean air act amendments established the first large scale long term environmental program to rely on tradable emissions permitscalled allowances in this program to control pollution this program was designed to cut acid rain by reducing sulfur dioxide so2 emissions from electric generating plants to about half their 1980 level beginning in 1995 it is of interest both as a response to an important environmental issue and as a landmark experiment in environmental policy this experiment comes at a particularly important time since emission trading is under serious consideration with strong u s backing for use to deal with global climate change by curbing emissions of carbon dioxide co2 the economic stakes in climate change surpass those in acid rain by several orders of magnitude intergovernmental panel on climate change 1996 this article summarizes the results to date of our ongoing empirical analysis of compliance costs and allowance market performance under the u s acid rain program

dynamic environmental policy with strategic firms prices versus quantities abstract environmental regulators often have imperfect information about regulated firms abatement costs in this paper we compare taxes and emissions permits in a dynamic setting in which firms behave strategically the regulator updates policy over time based upon previous aggregate industry performance assuming that firms are not strategic we find that strategic firms facing an emissions tax have an incentive to overabate in order to obtain a lower tax in the future firms that trade emissions permits have a strategic incentive to reveal an artificially high permit price to obtain more permits in the future whether permits or taxes are preferred from a welfare standpoint depends upon how permit prices are determined taxes generate higher welfare when the low cost firm sets the permit price but permits generate higher welfare when the high cost firm sets the permit price

optimal capital structure and bankruptcy choice dynamic bargaining versus liquidation abstract we model a firm s optimal capital structure decision in a framework in which it may later choose to enter either chapter 11 reorganization or chapter 7 liquidation creditors anticipate equityholders ex post reorganization incentives and price them into the ex ante credit spreads using a realistic dynamic bargaining model of reorganization we show that the off equilibrium threat of costly renegotiation can lead to lower leverage even with liquidation in equilibrium if reorganization is less efficient than liquidation the added option of reorganization can actually make equityholders worse off ex ante even when they liquidate on the equilibrium path

measuring the agency cost of debt we adapt a contingent claims model of the firm to reflect the incentive effects of the capital structure and thereby to measure the agency costs of debt an underlying model of the firm and the stochastic features of its product market are analyzed and an optimal operating policy is chosen we identify the change in operating policy created by leverage and value this change the model determines the value of the firm and its associated liabilities incorporating the agency consequences of debt the optimal capital structure for a firm is now widely regarded to be determined by a broad range of factors including a mix of tax effects the various agency problems associated with different securities and the various costs of issuing securities including the costs created by adverse selection while the existence of a theoretical optimum has been demonstrated in a variety of papers a less explored area has been the construction of detailed models that enable us to measure each of the relevant factors for a particular company and thereby to determine the actual optimal mix for that firm this gap in our understanding is particularly glaring in the case of agency costs in order to allow a careful modelling of strategic relations the parameters of most agency models are either so simplified that it is impossible to associate them with measurable parameters of a real world case or else the models simply abstract from certain critical factors such as a robust measure of price risk that must be incorporated into any real application for example although we now understand that sinking funds dividend restrictions and other bond covenants help to resolve the conflict of interest between bondholders and equity we do not yet have much in the way of models with which to determine the optimal parameters of these very covenants contingent claims models can provide a consistent framework for multiperiod valuation that properly accounts for risk but they usually abstract from the agency factors entering capital structure decisions when using a contingent claims model to value a firm s securities it is common to take the value of the firm itself as governed by an exogenously defined stochastic process the value of the firm s securities are then derived from this underlying value and as merton 1974 points out in his paper on the pricing of risky debt the modigliani miller theorem obtains so that the value of the firm is independent of the value and the type of debt in order to apply the contingent claims techniques to a setting in which agency problems are central some adaptation is necessary in this paper we

generalized utilitarianism and harsanyi s impartial observer theorem harsanyi s impartial observer must consider two types of lotteries imaginary identity lotteries accidents of birth that she faces as herself and the real outcome lotteries life chances to be faced by the individuals she imagines becoming if we maintain a distinction between identity and outcome lotteries then harsanyi like axioms yield generalized utilitarianism and allow us to accommodate concerns about different individuals risk attitudes and concerns about fairness requiring an impartial observer to be indifferent as to which individual should face similar risks restricts her social welfare function but still allows her to accommodate fairness requiring an impartial observer to be indifferent between identity and outcome lotteries however forces her to ignore both fairness and different risk attitudes and yields a new axiomatization of harsanyi s utilitarianism

on the design of optimal grandfathering schemes for emission allowances to meet its commitment under the kyoto protocol the eu plans to implement an emissions trading system whith grandfathering of allowances besides having distributional impacts the choice of the grandfathering scheme may affect efficiency if firms anticipate how future allocations depend on upcoming decisions in this paper we determine central design rules for optimal grandfathering within a simple two period model we find that for small open trading systems where allowance prices are exogenous first best second period grandfathering schemes must not depend on firm specific decisions in the first period second best schemes correspond to a ramsey rule of optimal tax differentiation and are generally based on both previous emissions and output however ofr closed emissions trading systems i e endogeneous allowance prices firstand second best rules coincide and must not depend on previous output levels they consist of an assignment proportional to the emissions in the first period plus a term which does not depend on firm specific decisions in either of the two periods

efficiency costs of meeting industry distributional constraints under environmental permits and taxes many pollution related industries wield strong political influence and can e ectively veto policy initiatives that would harm their profits a politically realistic approach to environmental policy therefore seems to require the alleviation of significant profitlosses to these industries the regulatory authority can do this by freely allocating some emissions permits or by exempting some inframarginal emissions from a pollution tax however such policies compel the government to forego an e cient potential revenue source and to rely more heavily on ordinary distortionary taxes as a result achieving distributional objectives comes at a cost in terms of e ciency using analytically and numerically solved equilibrium models we analyze the e ciency costs implied by the distributional constraint that adverse impacts on profits in particular industries must be avoided both models indicate that the e ciency cost implied by this constraint dwarfs the other e ciency costs when the required amount of abatement is very small when the abatement requirement becomes more extensive however the cost of this constraint diminishes relative to the other e ciency costs of pollution control we also calculate the compensation ratio the share of potential policy revenue that the government must forego to protect the industries in question we show how this ratio is a ected by the extent of abatement supply and demand elasticities and the potential for end of pipe treatment one definition of this ratio corresponds to the share of pollution permits that must be freely allocated to prevent profit losses in the targeted industries numerical simulations of sulfur dioxide pollution control suggest that the bush administration s clear skies initiative would exceed this ratio freely allocating more permits than necessary to preserve profits our models also highlight significant di erences between gross and net policy revenues when abatement is extensive a large fraction of the revenue collected from emissions permits or taxes is o set by the revenue loss from erosion of the base of existing factor taxes

terminating links between emission trading programs abstract links between emission trading programs are not immutable as highlighted by new jersey s exit from the regional greenhouse gas initiative in 2011 this raises the question of what to do with existing permits that are banked for future use choices that have consequences for market behavior in advance of or upon speculation about delinking we consider two delinking policies one differentiates banked permits by origin the other treats banked permits the same we describe the price behavior and relative cost effectiveness of each policy treating permits differently generally leads to higher costs and may lead to price divergence even with only speculation about delinking

the optimal distribution of pollution rights in the presence of political distortions a critical issue in designing a system of tradable emission permits concerns the distribution of the initial pollution rights the purpose of this paper is to investigate how the initial rights should be optimally set when the determination of the number of tradable permits is subject to the influence of interest groups according to the coase theorem in the case where there are low transaction costs the assignment of the initial rights does not affect the efficiency of the final resource allocation in the presence of political pressure we show that the distribution of the initial rights has a significant effect on social welfare in contrast to the conventional results we find that grandfathered permits may be more efficient than auctioned permits even after taking into consideration the revenue recycling effect

seller incentive properties of epa s emission trading auction abstract the new clean air act amendments instruct the environmental protection agency epa to conduct annual sealed bid offer auctions of emission allowances the auction pricing rules are discriminative and sellers with the lowest asking prices receive the highest bids this paper assesses the seller incentives of this auction and demonstrates that the auction rules cause sellers to choose asking prices that under reveal their cost of emission control furthermore increasing the number of sellers intensifies this misrepresentation if the number of buyers remains fixed the epa s rules can therefore generate significantly biased price signals and reduce the efficiency of the allowance trading market

economic incentives for environmental protection integrating theory and practice for decades economists have been extolling the virtues of market based or economic incentive approaches to environmental protection some 70 years ago arthur cecil pigou 1920 suggested corrective taxes to discourage activities that generate externalities a half century later j dales 1968 showed how the introduction of transferable property rights could work to promote environmental protection at lower aggregate cost than conventional standards from these two seminal ideas corrective taxes and transferable property rights a substantial body of research has developed both environmental taxes and marketable permits are coming of age in the policy arena examples include the introduction of marketable permits in the united states to control acid rain the use of changes in europe to limit air and water pollution and the employment of deposit refund schemes for products ranging from beverage containers to batteries the introduction of these tools on a large scale provides a unique opportunity to extend the frontiers of knowledge this essay strives to identify prominent issues that merit investigation 8 refs

a proximate mirror greenhouse gas rules and strategic behavior under the us clean air act the development of climate policy in the united states mirrors international developments with efforts to initiate a coordinated approach giving way to jurisdictions separately taking actions the centerpiece of us policy is regulation in the electricity sector that identifies a carbon emissions rate standard intensity standard for each state but leaves to states the design of policies including potentially the use of technology policies emissions rate averaging or cap and trade differences in policies among states within the same power market could promote predatory behavior resulting in a geographic shift in generation and investment in new resources this paper examines the coordination problem using a detailed partial equilibrium model of operations and investment we demonstrate that leading jurisdictions have available a rich set of design options including targetted output based allocation that would impose costs on neighbors and may protect against strategic predation

europe s climate goals and the electricity sector abstract eu s objective of attaining 20 reductions in greenhouse gas emissions by 2020 is analysed with a general equilibrium model detailing electricity generation technologies and capital vintaging consistent with theory and other analysts we find that the nonuniform treatment of emitting sectors in eu raises abatement costs by a factor of two to three under cost effective emission reductions a more comprehensive tradable cap electricity generation abates more than its proportional share in emissions the european economy abates by substitution towards natural gas by energy efficiency improvements and by reductions in emission intensive manufactures applied policies such as renewable support and responses such as carbon leakage hold down the prices for emission and electricity thus also holds down incentives for energy efficiency and technological change this leads to little preparation for the future and global mitigation

the political economy of market based environmental policy the u s acid rain program the u s acid rain program enacted in 1990 gave valuable tradable sulfur dioxide emissions permits called allowances to electric utilities we examine the political economy of this allocation though no senate or house votes were ever taken hypothetical votes suggest that the actual allocation would have beaten plausible alternatives while rent seeking behavior is apparent statistical analysis of differences between actual and benchmark allocations indicates that the legislative process was more complex than simple models suggest the coalition of states that produced and burned high sulfur coal both failed to block acid rain legislation in 1990 and received fewer allowances than in plausible benchmark allocations some of these states may have received additional allowances to cover 1995 99 emissions by giving up allowances in later years and some major coal producing states seem to have focused on benefits for miners and on sustaining demand for high sulfur coal

output based allocations in pollution markets with uncertainty and self selection we study pollution permit markets in which a fraction of permits are allocated to firms based on their output output based allocations which are receiving increasing attention in the design of carbon markets around the world e g europe california new zealand are shown to be optimal under demand and supply volatility despite the output distortions they may create in a market that covers multiple sectors the optimal design combines auctioned permits with output based allocations that are specific to each sector and increasing in its volatility when firms are better informed about the latter or must self select the regulator resort to some free i e lump sum allocations to sort firms out numerical exercises illustrate the policy relevance of our results the gains from considering output based allocations can be substantial

economic prescriptions for environmental problems how the patient followed the doctor s orders o ne of the dangers with ivory tower theorizing is that it is easy to lose sight of the actual set of problems which need to be solved and the range of potential solutions as one who frequently engages in this exercise i can attest to this fact in my view this loss of sight has become increasingly evident in the theoretical structure underlying environmental economics which often emphasizes elegance at the expense of realism in this paper i will argue that both normative and positive theorizing could greatly benefit from a careful examination of the results of recent innovative approaches to environmental management the particular set of policies examined here involves two tools which have received widespread support from the economics community marketable permits and emission charges pigou 1932 dales 1968 kneese and schultze 1975 both tools represent ways to induce businesses to search for lower cost methods of achieving environmental standards they stand in stark contrast to the predominant command and control approach in which a regulator specifies the technology a firm must use to comply with regulations under highly restrictive conditions it can be shown that both of the economic approaches share the desirable feature that any gains in environmental quality will be obtained at the lowest possible cost baumol and oates 1975 until the 1960s these tools only existed on blackboards and in academic journals as products of the fertile imaginations of academics however some countries have recently begun to explore using these tools as part of a broader strategy for managing environmental problems

interactions of corporate financing and investment decisions a dynamic framework this article analyzes the interaction between a firm s dynamic investment operating and financing decisions in a model with operating adjustment and recapitalization costs using numerical analysis we solve the model for cases that highlight interaction effects we find that higher production flexibility due to lower costs of shutting down and reopening a production facility enhances the firm s debt capacity thereby increasing the net tax shield value of debt financing while higher financial flexibility resulting from lower recapitalization costs has a similar effect production flexibility and financial flexibility are to some extent substitutes we find that the impact of debt financing on the firm s investment and operating decisions is economically insignificant

optimal capital structure and investment decisions under time inconsistent preferences based on a continuous time model of quasi hyperbolic discounting this paper provides an analytically tractable framework of entrepreneurial firms capital structure and investment decisions under time inconsistent preferences inefficiency in both investment and default is caused due to time inconsistency if we view the time consistent benchmark as efficient compared to the standard trade off theory in corporate finance we clarify that debt financing under time inconsistent preferences brings a new trade off between the alleviation effect on investment inefficiency and the aggravation effect on default inefficiency the impact of time inconsistent preferences depends on the entrepreneurs belief regarding their future time inconsistent behavior i e sophisticated or naive concretely we find that naive entrepreneurs always choose higher leverages while sophisticated ones are more likely to choose lower leverages compared to the time consistent benchmark therefore time inconsistency can explain the observed leverage puzzle i e why firms choose different leverages even with similar fundamentals moreover we demonstrate that time inconsistent preferences delay investment and hasten default due to the interaction among the three effects option value effect payoff value effect and leverage effect in particular naive entrepreneurs invest later and default earlier than sophisticated ones leading to a shorter operating period these results support the empirical findings in entrepreneurial finance

prices vs quantities the political perspective regulation regimes subject to the influence of interest groups are compared it is shown that the allocation of the regulated commodity varies with the implemented control and that the advantage of prices vs quotas increases with the elasticity of the demand for or the supply of the commodity and decreases with the number of organized producers in the regulated industry control regimes can be ranked for negative but not positive externalities finally a control regime leading to a more efficient commodity allocation also entails using fewer resources in rent seeking activities

asset sale debt restructuring and liquidation this paper considers a dynamic model in which shareholders of a firm in distress have a choice of whether the firm proceeds to debt restructuring or direct liquidation at an arbitrary time in the model we show the following results fewer asset sales lower financing debt renegotiation and running costs a lower premium to the debt holders a lower cash flow volatility and a higher initial coupon increase the shareholders incentive to choose debt restructuring to avoid full liquidation in the debt renegotiation process the shareholders arrange the coupon reduction and use equity financing to retire a part of the debt value to the debt holders the timing of debt restructuring always coincides with that of liquidation without debt renegotiation most notably the shareholders do not prefer asset sale in debt restructuring even if they face high financing costs the possibility of debt renegotiation in the future increases the initial leverage ratio in the optimal capital structure

international emissions trading with endogenous allowance choices abstract this paper compares endogenous choices of tradable and non tradable emission allowances by non cooperative countries i find that the cost savings of trading do not necessarily lead to less pollution in particular environmentally more concerned countries usually choose less allowances if these are tradable but this may be offset by the choice of more allowances on the side of environmentally less concerned countries moreover if the establishment of a trading system requires the unanimous approval of all countries there may be no agreement on trading even if it were to lead to less pollution overall conversely a trading system may find unanimous approval even if it induces more pollution

optimal exercise of jointly held real options a nash bargaining approach with value diversion this paper provides a two stage decision framework in which two or more parties exercise a jointly held real option we show that a single party s timing decision is always socially efficient if it precedes bargaining on the terms of sharing however if the sharing rule is agreed before the exercise timing decision is made then socially optimal timing is attained only if there is a cash payment element in the division of surplus if the party that chooses the exercise timing can divert value from the project then the first best outcome may not be possible at all and the second best outcome may be implemented using a contract that is generally not optimal in the former cases our framework contributes to the understanding of a range of empirical regularities in corporate and entrepreneurial finance

the market for sulfur dioxide emissions the 1990 clean air act amendments initiated the first large scale use of the tradable permit approach to pollution control the theoretical case for this approach rests on the assumption of an efficient market for emission rights the authors empirical analysis shows that the emission rights market created by the 1990 amendments had become reasonably efficient by mid 1994 they also show that the auctions specified in the amendments to jump start trading had become a small part of the overall market finally the authors demonstrate that the strategic bidding behavior discussed in the literature has had no effect on market prices copyright 1998 by american economic association

contracting with externalities the paper studies inefficiencies arising in contracting between one principal and n agents when the utility of each agent depends on all agents trades with the principal when the principal commits to a set of publicly observable bilateral contract offers the arising inefficiency is due entirely to the externalities imposed on non signers in contrast when the principal s offers are privately observed the distortion is due to the externalities given agents equilibrium trades comparison of the two externalities determines the relative efficiency of the two contracting regimes in both cases we show that when n is large each agent can be treated as non pivotal provided that appropriate continuity assumptions are satisfied we also study the case in which the principal can condition each agent s trade on other agents messages we characterize the set of such mechanisms in which each agent s participation is voluntary when the principal can commit to any such mechanism she implements the first best outcome while threatening each deviator with the harshest possible punishment however in the presence of noise that goes to zero slower than n goes to infinity in the limit we obtain a generally inefficient outcome in which each agent feels non pivotal

transaction costs and tradeable permits abstract tradeable permit systems are at the center of current interest and activity in market based reforms of environmental policy because these systems can offer significant advantages over conventional approaches to pollution control unfortunately claims made for their relative cost effectiveness have often been exaggerated transaction costs which may be significant in these markets reduce trading levels and increase abatement costs in some cases equilibrium permit allocations and hence aggregate control costs are sensitive to initial permit distributions providing an efficiency justification for politicians typical focus on initial allocations

incentives and prices in an emissions trading scheme with updating abstract emissions trading schemes where allocations are based on updated baseline emissions give firms less incentive to reduce emissions for a given quota or allowance price nevertheless according to bohringer and lange on the design of optimal grandfathering schemes for emission allowances europ econ rev 49 2005 2041 2055 such allocation schemes are cost effective if the system is closed and allocation rules are identical across firms in this paper we show that the cost effective solution may be infeasible if marginal abatement costs grow too fast moreover if a price cap or banking borrowing is introduced the abatement profile is no longer the same as in the case with an auction or lump sum allocation in addition we show that with allocation based on updated emissions the quota price will always exceed marginal abatement costs possibly misguiding policy makers and investors about abatement costs numerical simulations indicate that the quota price most likely will be several times higher than marginal abatement costs unless a significant share of allowances is auctioned

bailouts the incentive to manage risk and financial crises a firm s termination leads to bankruptcy costs this may create an incentive for outside stakeholders or the firm s debtholders to bail out the firm as bankruptcy looms because of this implicit guarantee firm shareholders have an incentive to increase volatility in order to exploit the implicit protection however if they increase volatility too much they may induce the guarantee extending parties to walk away i derive the optimal risk management rule in such a framework and show that it allows high volatility choices while net worth is high however risk limits tighten abruptly when the firm s net worth declines below an endogenously determined threshold hence the model reproduces the qualitative features of existing risk management rules and can account for phenomena such as flight to quality

mitigation incentives with climate finance and treaty options abstract future greenhouse gas ghg mitigation action of current non climate policy np countries is considered to take two alternative forms 1 climate finance payments received in return for future reductions in its ghg emissions below a defined baseline and 2 join a climate treaty whereby the required emissions reductions are formally binding it is assumed that baselines defining climate finance payments and required emissions reductions under a treaty depend positively on current emissions it is then shown that making such future options available reduces current ghg mitigation in np countries leading to higher emissions in the short run this effect is stronger when future climate finance payments are higher the required relative emissions reductions under a treaty are greater when commitments under a treaty are longer lasting and mitigation targets depend more on current emissions such short run increases in emissions can sometimes more than fully eliminate the effect of the subsequent policy when climate finance and treaties are both future alternatives more generous climate finance can make it harder and more expensive to induce the country to join a climate treaty

costs of alternative environmental policy instruments in the presence of industry compensation requirements abstract this paper explores how the costs of meeting given aggregate targets for pollution emissions change with the imposition of the requirement that key pollution related industries be compensated for potential losses of profit from the pollution regulation we apply a numerically solved general equilibrium model to compare the incidence and costs of emissions taxes fuel intermediate input taxes performance standards and mandated technologies in the absence and presence of this compensation requirement compensation is provided either through industry tax credits or industry specific cuts in capital tax rates we analyze the added costs from the compensation requirement in terms of 1 an increase in intrinsic abatement cost reflecting a lowered efficiency of pollution abatement and 2 a lump sum compensation cost that captures the efficiency costs of financing the compensation the compensation requirement affects these components differently depending on the policy instrument involved and the required extent of pollution abatement as a result it can change the cost rankings of the different instruments in particular when compensation is provided through lump sum tax credits the lump sum compensation cost is higher under the emissions tax than under the command and control policies performance standards and mandated technologies a reflection of the higher compensation requirements under the emissions tax when the required pollution reduction is modest imposing the compensation requirement causes the emissions tax to lose its status as the least costly instrument and to become more costly than command and control policies in contrast when required abatement is extensive the emissions tax again becomes the most cost effective instrument because of its advantages in terms of lower intrinsic abatement cost

output based allocation of emissions permits for mitigating tax and trade interactions the allocation of tradable emissions permits has important efficiency as well as distributional effects when tax and trade distortions are taken into account we compare different rules for allocating carbon allowances within sectors lumpsum grandfathering output based allocation oba auctioning and among sectors historical emissions or value added shares the output subsidies implicit in oba mitigate tax interactions unlike grand fathering oba with sectoral distributions based on value added is similar to revenue recycling with auctioning oba based on historical emissions supports heavier polluters more effectively counter acting carbon leakage but at higher welfare costs less energy intensive sectors are also sensitive to allocation rules

zero leverage and the value in waiting to have debt abstract this paper documents that the real option to have debt motivates some firms to remain debt free even when standard trade off theory predicts that these firms should have leverage the real option has a first order effect similar to the effect of bankruptcy costs in addressing the zero leverage puzzle the observation that many firms seemingly forgo sizable debt benefits by remaining debt free the debt free firms value includes the option whose value is derived from future debt benefits and hedging bankruptcy costs this paper proposes an optimal timing model for having debt and finds support for the model s predictions through calibrations and simulations

price cap versus rate of return regulation in a stochastic cost model a stochastic cost model is used to show that both price cap and rate of return regulation lead to overinvestment in capital and to excessive managerial slack however they differ in stochastic versus fixed intervals between hearings and in the use of test year costs versus average costs since the previous hearing a numerical example illustrates that fixed intervals between hearings improve welfare if hearings are not held too frequently but most gains go to the firm more significantly the use of average cost data combined with fixed intervals results in dramatic welfare improvements with most gains going to consumers

emissions trading with offset markets and free quota allocations we study optimal climate policy for a policy bloc of countries facing a market where emissions offsets can be purchased from a non policy fringe of countries such as with the cdm policy bloc firms benefit from free quota allocations which are updated according to either firms past emissions or outputs we show that the resulting abatement and its allocation between policy bloc and fringe are both inefficient when all quotas are traded freely at a single price the policy bloc chooses to either not constrain the offset market leading to suboptimal policy bloc mitigation or ban offsets completely the former latter case occurs when free allocation of quotas is not very generous and the offset market is large small it is preferable for policy bloc countries governments to instead buy offsets directly from the fringe at a quota price below marginal damage cost of emissions while the policy bloc quota price will be above this cost with maximization of global welfare and a unified quota price this price is higher and offsets constrained in fewer cases but the solution still inefficient full efficiency then requires a higher quota price in the policy bloc than in the fringe

market power and transferable property rights the appeal of using markets as a means of allocating scarce resources stems in large part from the assumption that a market will approximate the competitive ideal when competition is not a foregone conclusion the question naturally arises as to how a firm might manipulate the market to its own advantage this paper analyzes the issue of market power in the context of markets for transferable property rights first a model is developed that explains how a single firm with market power might exercise its influence this is followed by an examination of the model in the context of a particular policy problem the control of particulate sulfates in the los angeles region

dynamic investment and capital structure under manager shareholder conflict abstract this paper investigates the interactions between the investment and financing decisions of a firm under manager shareholder conflicts arising from asymmetric information in particular we extend the manager shareholder conflict problem in a real options model by incorporating debt financing we show that manager shareholder conflicts over investment policy increase not only the investment and default triggers but also coupon payments which lead to a decrease in the equity value moreover given the presence of manager shareholder conflicts debt financing increases investment and decreases total social welfare as a result there is a trade off between the efficiency of investment and total social welfare with debt financing these results fit well with the findings of previous empirical work in this area

liquidation fire sales and acquirers private information abstract we develop a dynamic model in which a distressed firm optimizes an exit choice between sell out and default as well as its timing we assume that the distressed firm is not informed about the acquirer s asset valuation we show that the firm delays liquidation to decrease the acquirer s information rent notably the firm can change the exit choice from sell out to default when the screening cost is high in this case shareholders declare default regardless of the acquirer s valuation which provides the acquirer the maximum information rent together with the deadweight costs of bankruptcy the maximal information rent which causes a wealth transfer from debt holders of the bankrupt firm to the acquirer lowers the sales price and debt recovery this mechanism can explain many empirical findings about fire sales and acquirers excess gains higher volatility leverage and asymmetric information increase the likelihood of a fire sale but higher bankruptcy costs could play a positive role in preventing a fire sale with asymmetric information the firm can reduce debt issuance to avoid the risk of a fire sale

permanent differences in unemployment and permanent wage differentials this paper tests for the existence of wage premiums based on geographic and industry unemployment differences these differences are broken down into permanent and transitory components in equations controlling for variation in state generosity of unemployment insurance benefits findings indicate that wage premiums arise for long run unemployment differences but that negative short run shocks to industries generate wage cuts while positive shocks generate wage hikes therefore labor contracts accommodate long term anticipated unemployment and entail sharing of short term unemployment risks

a ten year rule to guide the allocation of eu emission allowances abstract member states in the european union eu are responsible for national allocation plans governing the initial distribution of emission allowances in the co2 emission trading system including rules governing allocations to installations that close and to new entrants the european commission has provided guidelines to discourage the use of allocation methodologies that provide incentives affecting firms compliance behavior for example by rewarding one type of compliance investment over another we find that the treatment of closures and new entrants by member states is inconsistent with the general guidelines provided by the eu we propose stronger eu guidance regarding closures and new entrants a more precise compensation criterion on which to justify free allocations and a ten year rule as a component of future eu policy that can guide a transition from current practice to an approach that places greater weight on efficiency

debt valuation renegotiation and optimal dividend policy the valuation of debt and equity reorganization boundaries and firm s optimal dividend policies are studied in a framework where we model strategic interactions between debt holders and equity holders in a game theoretic setting which can accommodate varying bargaining powers to the two claimants two formulations of reorganization are presented debt equity swaps and strategic debt service resulting from negotiated debt service reductions we study the effects of bond covenants on payout policies and distinguish liquidity induced defaults from strategic defaults we derive optimal equity issuance and payout policies the debt capacity of the firm and the optimal capital structure are characterized

an experimental investigation of the seller incentives in the epas emission trading auction the clean air act requires the epa to conduct annual auctions of emission allowances under the discriminative auction rules sellers with the lowest asking prices receive the highest bids this paper studies an inverted version of this auction in which buyers face the same incentives as sellers in the epa auction consistent with theoretical predictions buyers bid above their valuation auction outcomes are inefficient and increasing the number of buyers increases bids buyers facing human opponents compete more aggressively than the risk neutral prediction but bids do not differ systematically from this prediction when buyers face computerized nash robots copyright 1995 by american economic association

developing real option game models by mixing concepts from both game theoretic analysis and real options theory an investment decision in a competitive market can be seen as a game between firms as firms implicitly take into account other firms reactions to their own investment actions we review two decades of real option game models suggesting which critical problems have been solved by considering game theory and which significant problems have not been yet adequately addressed we provide some insights on the plausible empirical applications or shortfalls in applications to date and suggest some promising avenues for future research

harmonization and side payments in political cooperation for two districts or countries that try to internalize externalities i analyze a bargaining game under private information i derive conditions for when it is efficient with uniform policies across regions with and without side payments and when it is efficient to prohibit side payments in the negotiations while policy differentiation and side payments allow the policy to better reflect local conditions they create conflicts between the regions and thus delay the results also describe when political centralization outperforms decentralized cooperation and they provide a theoretical foundation for the controversial uniformity assumption traditionally used by the fiscal federalism literature

small pollution markets tradable permits versus revelation mechanisms abstract a simple two period model with two polluters is analyzed they emit a homogeneous hazardous substance and they are given tradable permits to pollute the social planner issues permits and tries to learn the cost of reducing pollution by observing the quantity of permits traded in the first period it is shown that although efficient trade is prevented by strategic considerations by the polluters the planner learns something from observing only quantities comparisons are made between this approach and that of mechanism design and it is concluded that the latter is superior in theory but sensitive to collusion by the firms

a presumptive pigovian tax complementing regulation to mimic an emissions fee if regulations are used to make cars and fuels cleaner should gasoline taxes be used to manage demand for trips that pollute anaysis of a well composed program for mexico city indicates that the emission reductions would cost 24 percent more if a tax on gasoline was not introduced a simple analytical framework is developed to analyze the use of abatement requirements to make cars cleaner and a gasoline tax to economize on the use of cars the two instruments should be combined to mimic the incentives that would have beeen provided by an emissions fee thus cleaner cars and fewer trips are analogous to competing suppliers of emission reductions the planner should buy from both so that marginal costs are equal applying that rule the marginal cost of emission reductions is simply the gasoline tax rate divided by emissions per liter

distressed exchange bargaining power and prior capital structure abstract financially troubled companies often make distressed exchange de offers to its creditors to postpone costly bankruptcy reorganization we derive the optimal terms and timing of a de offer consisting of debt reduction and an equity stake in the restructured firm the de terms and timing are affected by shareholder bargaining power with greater shareholder bargaining power resulting in earlier de offer smaller debt reduction and smaller equity stake the impact of shareholder bargaining power is greater when bankruptcy cost is larger and tax rate is higher we also show that renegotiability of debt increases ex ante firm value and results in a higher optimal leverage ratio both firm value and optimal leverage ratio are decreasing functions of shareholder bargaining power

default and renegotiation a dynamic model of debt we analyze the role of debt in persuading an entrepreneur to pay out cash e ows rather than to divertthem in the e rstpartof the paper we study the optimal debt contract specie cally the trade off between the size of the loan and the repayment under the assumption that some debt contract is optimal in the second part we consider a more general class of nondebt contracts and derive sufficient conditions for debt to be optimal among these