Essays on environmental policy and markets

This dissertation consists of two theoretical papers on market-based environmental policy. The first paper exploits the correlation between the environmental performance of firms and their economic performance to show that financial markets can be used to help enforce environmental policy and to design more efficient regulations. The results indicate that when markets punish firms for not complying with environmental standards, environmental regulators can exploit this by setting stricter standards. In fact, it is possible for the regulator to use market-driven enforcement to reduce a firm’s emissions and monitoring of the firm simultaneously. The second paper provides a theoretical analysis of the nature of an optimal emissions tax when firms’ emissions are not perfectly observable. The purpose is to examine how the optimal tax is affected by enforcement costs and the market structure. We obtain the result that market imperfections and enforcement costs push the optimal tax lower than the marginal damage when the number of firms in the market is exogenous. However, when the number of firms is determined endogenously enforcement costs generate two countervailing effects on the optimal tax. The overall effect of enforcement costs on the optimal tax depends on the strength of direct relative to indirect effects when there is free entry and exit