The EU ETS and Firm Financial Performance: Evidence from the Electricity Sector

Abstract

Prior studies on the economic consequences of the European Union Emissions Trading System (EU ETS) on European electricity generating firms have so far re-lied on data from the first phase of the scheme that ended in 2007. We address this gap and find that EU ETS emission allowance price increases (decreases) have a positive (negative) impact on stock return by employing multifactor models with a balanced longitudinal dataset covering thirteen European electricity generating firms during the third phase of the EU ETS. Moreover, we find that the positive relationship is stronger for firms with carbon efficient electricity generation. Based on the Arbitrage Pricing Theory and the Efficient Market Hypothesis, we argue that price appreciations in EU ETS emission allowances positively affect firm performance for European electricity generating firms in general and carbon efficient generators in particular. A possible explanation is that inframarginal suppliers obtain regulatory rent due to the pass-through of the marginal producer’s additional emission compliance cost to consumers. This suggests that the EU ETS is successful in financially incentivizing profit maximizing firms concerned with electricity generation to decarbonize operations, which may be of interest to policymakers considering more stringent emission compliance costs for other sectors.