Internal Carbon Markets and Corporate Carbon Emissions in the EU ETS

Title: Internal Carbon Markets and Corporate Carbon Emissions in the EU ETS

Abstract: I examine the internal carbon markets of firms covered by the European Union Emissions Trading System. Firms with internal carbon markets reallocate more carbon allowances from (to) subsidiaries with generous (modest) free allowance allocation to (from) those with modest (generous) free allowance allocation after allowances become relatively scarce. In response to allowance scarcity, subsidiaries of firms with internal carbon markets also become 6% more carbon intensive. Additional results indicate that the increase in carbon intensity is primarily driven by the agency conflict introduced by the prospect of ex-post intra-firm resource reallocation that distorts ex-ante incentives to make these resources available in the first place. Overall, the results demonstrate that frictions in resource reallocation within firms could play an important role in the effectiveness of climate policy.