The Impact of Green Regulation on Cost Stickiness

Abstract

This study examines the impact of green regulation on cost stickiness at the firm level. We exploit the introduction of the European Union’s Emission Trading Scheme (EU-ETS) in 2005 as a unique setting to show that regulated firms experienced a significant shift in cost stickiness in the EU-ETS period (compared to control firms). This result can be attributed to firms pursuing green investments incentivized by the EU-ETS. Furthermore, cost stickiness is stronger for regulated firms in the EU-ETS period that exhibit higher levels of capital expenses (over total assets) and financial constraints, corroborating our interpretation that green investments triggered by the EU-ETS cause sticky cost behavior. Our findings are robust to using (i) an alternative variable of expenses associated with cost stickiness, (ii) a battery of control variables, (iii) an entropy balancing matching method, and (iv) a variety of econometric specifications taking into account potential asymmetric cost behavior.