Cap-and-trade under a dual-channel setting in the presence of information asymmetry

Abstract

Cap-and-trade, a widely used carbon regulation policy, encourages firms to adopt carbon abatement technologies to reduce emissions. Traditional supply-chain literature on this policy assumes symmetrical information, overlooking the fact that carbon abatement efforts and costs are often private and vary significantly across geographies, industries, and pollutants. In this paper we explore a dual-channel setting involving a manufacturer and a retailer, where the manufacturer, subject to cap-and-trade regulations, has undisclosed information about its carbon abatement costs. Our findings reveal that high abatement costs can paradoxically benefit the manufacturer, the environment, consumers, and overall social welfare. Our result also cautions that a higher carbon trading price (e.g., due to more ambitious emission reduction targets) can disincentivize the manufacturer from investing in carbon abatement. Moreover, a higher production cost, while resulting in lower market output, can increase pollution generation. We contribute the following to the practitioner debate about the impact of carbon policies: for an industry with a large market size, our findings lend support to governments to implement a cap-and-trade policy, because the manufacturer, customers and social welfare can be better off under a cap-and-trade policy than under a tax policy or no carbon policy. Additionally, we suggest that in such industries, governments need not enforce information transparency within the supply chain.