VIETNAM NATIONAL UNIVERSITY UNIVERSITY OF ECONOMICS AND BUSINESSGRADUATION THESIS CASH FLOW VOLATILITY UNDER THE EMISSION TRADING SCHEME IMPLEMENTATION: WHAT CAN WE LEARN FROM CHINA?. Al
INTRODUCTION 1115
Define research objectives and tasSÌKS -s -csscrrtkkkiitriiirrkirrriirrriiirriirrrrirriirrrrirri 10 1.3 ResearCh SCOPES eesssssssssessessesssessessesssecseesssstscsecseessesseeseeseeseeseeseesuecseeseesneeseeseesesseeseeseeatecseeseeaseeserass 11 1.4 Overview of research methodology 1.5 Contribution of research .eesseesseseessecsesseesseessesssesssessecsecsecssesseeseesseeeseecseecsteeseeeseesneesseesseeses 1.6 Structure Of the Study cccecsesessescssesssecsessssesseesssesseessessseessessseeseesseessesseseseeeseeeseersseasesasenseeesseses 12
This research aims to explore the impact of an Emissions Trading System (ETS) on firms' cash flow volatility (CFV) and assess the resilience of cash flow uncertainty in response to environmental regulations The study seeks to provide valuable insights for board managers to enhance financial performance and support economic growth in the country Additionally, it examines the extent to which ETS influences CFV and draws lessons from China's experience to aid in the development of a low-carbon and sustainable system in Vietnam.
This study investigates the impact of the Emissions Trading System (ETS) program on firms' carbon financial value (CFV) in China It analyzes data from 2010 to 2019, focusing on the pilot implementation of the ETS that started in 2013 with seven provinces participating in the program.
Launched in 2013, China's ETS project began in major cities like Beijing, Tianjin, Shanghai, and Guangdong, expanding to Hubei and Chongqing in 2014, and Fujian in 2016 This initiative has successfully reduced approximately 1,400 million tons of CO2-equivalent emissions, involving over 3,200 organizations (ICAP, 2019) As the world's largest emitter, China aims to peak carbon emissions by September 2020 and achieve carbon neutrality by 2060 (Yu et al., 2021; Wang et al., 2016; Nie et al., 2017) Despite these efforts, challenges persist, including an imperfect trading mechanism and a short-term focus in the carbon trading market (Liu et al., 2015) Additionally, limited research has been conducted on the ETS's impact on carbon footprint variations (CFV) in China, indicating a need for further studies to inform policy proposals for other emerging nations.
The paper utilizes data from over 9570 high emitted firms in China from 2010 to
A staggered difference-in-difference (DID) analysis conducted in 2019 reveals that the Emissions Trading System (ETS) significantly amplifies cash flow fluctuations for firms in high-carbon industries The findings indicate that ETS may elevate risks for these businesses, as carbon risk can lead to non-diversifiable risk premiums and distress risks (Nguyen and Phan, 2020; Safiullah et al., 2021) Additionally, these firms could incur higher compliance costs and face environmental penalties, potentially jeopardizing their profitability and growth prospects (Stroebel and Wurgler, 2021; Cai et al., 2016) This aligns with Ni et al (2022), who argue that while ETS can encourage risky investments with long-term value, it simultaneously heightens distress risk, affecting cash flow.
1 Beijing, Tianjin, Shanghai, Guangdong, Fujian, Hubei, and Chongqing.
My findings also confirm Nguyen and Phan's (2020) research, which showed that the increase in carbon risk can translate into a higher risk of financial distress.
This study enhances the existing literature on Emission Trading Systems (ETS) by examining its ambiguous impacts on firm performance, which have gained attention from policymakers and economists only in recent years While previous research has linked ETS to both positive effects, such as increased investment efficiency and negative effects like reduced market power, its influence on cash flow risk management remains largely unexplored This paper uniquely addresses this gap by considering performance turbulence, providing empirical insights into the darker implications of ETS on firms' risk management Furthermore, it advances the understanding of cash flow volatility (CFV) determinants under ETS, an area that has not been thoroughly investigated despite earlier studies focusing on related aspects Ultimately, the findings serve as a valuable reference for managers and policymakers, highlighting the significance of CFV in assessing a firm's performance through the lens of cash flow dynamics.
This paper is structured as follows: Chapter 2 reviews existing literature and formulates testable hypotheses Chapter 3 outlines the research design of the study, and Chapter 4 presents the empirical findings Following the initial results, the study will perform robustness tests and further analyses to explore the research questions more thoroughly Finally, Chapter 5 concludes the study with practical recommendations.
LITERATURE REVIEW .c:cssssssssssssssssstesssnseesssssesssntesssnteessnseesssneesssnseeesnneessnneeeesneseen 13 2.1 Research background esseessessecsessecstecstssseessseessecsesstecstecseecseecateestecseesstseaeesatecsessatesaeenseesaenes 13 2.1.1 Institutional framework Of 957007
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China, the largest developing country and the top emitter of carbon dioxide and greenhouse gases globally, accounted for 27% of the world's carbon emissions and a third of total greenhouse gases as of 2022 (World Bank, 2022) From 1990 to 2018, China's emissions surged by 269%, peaking at nearly 13,000 MtCO2, primarily driven by its energy and industrial sectors (Climate Analytics, 2021) Despite having an emissions intensity of 68.6 tCO2/TJ in 2021—20% higher than the G20 average—China's emissions peaked at 75 tCO2/TJ in 2013 (Climate Transparency, 2021) In response to these challenges, China has pledged to reduce carbon intensity by 2030 and achieve carbon neutrality by 2060 as part of its commitments under the Paris Agreement (Yu et al., 2021).
In October 2011, the National Development and Reform Commission (NDRC) initiated carbon emissions trading pilots to combat climate change and environmental degradation These seven pilot systems were developed collaboratively by provincial and municipal Development and Reform Commissions, local emissions trading exchanges, and academic experts The selection of these pilots was influenced by the willingness of provincial leaders to implement an emissions trading system (ETS) and the need to represent diverse economic, social, and geographic factors across China This strategic approach ensures that the pilots encompass a broad spectrum of economic and industrial contexts.
2016 They represent 18% of the population and 26.7% of the GDP (ICAP, 2022).
The basic framework of the nationwide carbon emission market was defined as
In 2014, the "Provisional Measures for the Administration of Carbon Emission Rights Trading" established foundational guidelines for a national Emissions Trading System (ETS), although it lacked technical specifics (International Emissions Trading Association, 2015; Huang et al, 2022) A year later, China Certified Emissions Reductions (CCER) credits were first surrendered for compliance in pilot schemes On January 11, 2016, the National Development and Reform Commission (NDRC) issued a significant Notice outlining key initiatives for the implementation of these measures.
Preparation for the Launch of the National ETS, paving the way for local-level work in preparation for the national ETS launch in 2017 (ICAP, 2016).
In late 2013, Beijing, Guangdong, Tianjin, and Shanghai launched their carbon trading markets, followed by Hubei and Chongqing in 2014, and Fujian in 2016 These seven provinces focus on high-emission sectors including power, transportation, buildings, industries, and manufacturing With an anticipated transaction value exceeding CNY 100 billion (USD 15.5 billion), China's Emissions Trading System (ETS) is poised to become the largest carbon market globally, playing a vital role in meeting the nation's dual carbon goals.
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The Emissions Trading System (ETS) has become a focal point of research regarding its impact on corporate performance, as it is a vital environmental regulation Studies indicate that companies reliant on external financing are particularly pressured by stakeholders in competitive markets (Ni et al., 2022) Participation in the carbon market exposes firms to heightened carbon risks linked to climate change, resulting in non-diversifiable risk premiums and distress (Wen et al., 2020; Nguyen and Phan, 2020; Safiullah et al., 2021) Furthermore, policies aimed at reducing carbon dioxide emissions may adversely affect firms' research and development investments due to increased costs and diminished investment intentions (Pan et al., 2021) High emitters often face elevated capital costs and reduced leverage (Nguyen and Phan, 2020), while carbon regulations can lead to increased idle assets and operating costs, particularly for those with significant carbon risk, ultimately resulting in severe economic implications (Nguyen, Truong, & Zhang, 2020).
Stricter carbon regulations lead to increased costs associated with carbon emissions, including management, cleanup, and litigation expenses Consequently, companies with higher carbon emissions face financial repercussions.
16 exposed to both carbon risk and higher marginal abatement costs An increase in corporate compliance costs can reduce profitability and future cash flow (Jung et al.,
High carbon risk significantly affects firms' sustainable operations and dividend distribution, leading to increased challenges in their financial activities Research by Li (2022) using a triple DID model indicates that China's Emissions Trading System (ETS) results in higher cash holdings, driven by heightened precautionary concerns and elevated compliance costs Similarly, Chen (2021) corroborates these findings through an analysis of 3,436 observations in China, highlighting the financial implications of carbon risk on businesses.
Cash flow refers to the income generated from a company's business activities, encompassing the entire value chain under the firm's control and aimed at optimizing market performance It signifies a company's capability to convert its assets and resources into monetary outcomes As a key performance indicator, cash flow effectively reflects a firm's financial strength while being less influenced by accounting biases that may favor specific interests.
Cash flow volatility (CFV) is an important yet underexplored aspect of financial literature, significantly influenced by a firm's assets, capabilities, knowledge, and strategic approaches, as noted by Luo and Bhattacharya (2009) Understanding CFV provides a reliable indicator of resource management and market performance Additionally, examining CFV from a retrospective viewpoint highlights that uncertainties in a firm's performance can arise from diverse operational factors, serving as a crucial warning signal for optimizing business activities to secure a consistent future income stream.
In 2020, researchers suggested that corporate social responsibility (CSR) can diminish a firm's cash flow volatility (CFV) at low to moderate engagement levels, while high levels of CSR involvement may lead to increased volatility This perspective is grounded in the resource-based view and dynamic capability theory.
To assess cash flow volatility, the coefficient of variation is frequently utilized, as it effectively eliminates the influence of scale differences due to varying firm sizes This method involves scaling the standard deviation, providing a clearer picture of cash flow variability across different organizations.
The analysis of cash flow volatility, measured by the five-year rolling standard deviation, provides a clear reflection of a firm's inherent volatility and facilitates meaningful comparisons across companies Previous studies by Sun and Ding (2020) and Huang and Tarkom (2022) have employed this method, while Huang (2020) examined how product market competition influences cash flow risk and labor investment efficiency This research follows the same methodology, utilizing annual cash flow data analyzed through a moving five-year window, as established in prior works (Larkin, 2013; Sun and Ding, 2020).
A forward-looking view of cash flow volatility (CFV) is crucial for assessing a firm's performance, influencing both stock returns and risk Investors closely monitor a company's financial strength through its income stability, as significant income fluctuations heighten shareholder risk and negatively impact stock valuation CFV can disrupt essential business activities, including research and development and advertising, leading to operational constraints that undermine overall performance and increase bankruptcy risk Consequently, CFV poses a dual threat to firms by limiting operational capabilities and alienating vital funding sources like debt holders and investors.
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Numerous studies have highlighted the impact of Environmental, Social, and Governance (ESG) factors on firm performance, influencing metrics such as stock returns (Wen, 2020), bank loan costs (Zhu et al., 2022a), and dividend payouts (Zhu et al., 2022b) While existing literature acknowledges both the positive and negative effects of ESG on economic decisions and outcomes, the relationship between cash flow volatility (CFV) and ESG remains largely unexplored CFV is critical to a firm's performance, reflecting the fluctuations in cash inflows and outflows, which can affect financial stability and the ability to meet short-term obligations, as well as influence investment, financing decisions, and operational efficiency Some research emphasizes the implications of ESG for investors (Bolton and Kacperczyk, 2021; Zhu, 2022), while others focus on operational aspects within firms (Chen et al.).
In 2021, previous studies examined various aspects of carbon markets (Wang and Zhang, 2022; Li, 2021), yet the issue of cash flow risk remains largely unexplored This study aims to bridge this research gap by being the first to evaluate the impact of the Emissions Trading System (ETS) on firms' cash flow volatility (CFV) in China.
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The literature on CFV forms two prevailing perspectives, including the Porter hypothesis and agency theory.
The Porter hypothesis, introduced by Michael Porter in 1991, posits that firms can gain from environmental regulations, as well-designed policies can drive innovation and enhance productivity Porter argues that stringent environmental policies, when implemented effectively, can boost productivity and competitiveness, benefiting both society and businesses In 1995, Porter identified two key ways that these regulations can enhance competitiveness: by forcing companies to uncover inefficiencies and by fostering innovation This perspective has gained support among policymakers, suggesting that environmental regulations can be advantageous for firms as well as society Specifically, well-designed Emission Trading Systems (ETS) can stimulate innovation, potentially offsetting compliance costs and improving competitiveness Research by Ni et al (2022) indicates that ETS can enable firms to adopt greener practices, enhancing their appeal to investors and stakeholders Additionally, Luo et al (2021) highlights that ETS can encourage the development of innovative technologies, promoting sustainable economic growth and leading to increased revenue and stable cash flow for businesses.
H1: The implementation of ETS will decrease the fluctuation of firms’ cashflows.
Some authors argue that companies may limit investments due to cash flow risks, as those facing greater cash flow uncertainty often adopt a more cautious approach (Huang et al., 2022) Agency theory highlights the dynamic between the 'master,' who holds socially legitimate control, and the 'servant,' who manages the information critical to decision-making.
Agency theory, introduced by Berle and Means (1932), explores the dynamics between owners and managers in modern firms where ownership and management are distinct This theory has evolved since the 1960s, focusing on the contractual relationship between principals and agents (Eisenhardt, 1989) Jensen and Mickling (1976) describe an agency relationship as one where principals delegate decision-making authority to agents, who may have differing interests due to information asymmetry To align these interests and minimize agency costs, principals can create incentives for agents This misalignment can lead to conflicts, particularly in the context of Environmental Trading Systems (ETS), where managers might prioritize personal gains over shareholder interests, potentially resulting in suboptimal investment decisions that negatively impact cash flow value (CFV) (Sheikh, 2022).
H2: The implementation of ETS will increase the fluctuation of firms’ cashflows.
In conclusion, since Chapter 2 presents both institutional settings of ETS and empirical evidence, I proposed two hypotheses and models in order to examine the influence of ETS on firms’ CFV.
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The primary independent variable of this study is the "Pilot," defined as a dummy variable that assigns a value of 1 to firms incorporated in provinces that adopted the ETS pilot program, specifically Guangdong, Shanghai, Tianjin, and Beijing starting in 2013, Hubei and Chongqing from 2014, and Fujian from 2016, while assigning a value of 0 to firms outside these regions A positive coefficient for this variable suggests that firms experience an increase in CFV after implementing the ETS, whereas a negative coefficient indicates a decrease.
The study integrates various control variables that reflect firm-specific characteristics influencing the firm's Cash Flow Variability (CFV), as highlighted in previous research (Huang and Tarkom, 2022; Beladi et al., 2021; Sun and Ding, 2020; Deng et al., 2013) Key variables include Firm Size, represented by the natural logarithm of total assets; Firm Age, calculated as the natural logarithm of operational years plus one; Price to Book Ratio (PB), derived by dividing market value by book value; and Cash Position (CASHRATIO), which measures the ratio of cash and cash equivalents.
The article discusses key financial metrics for evaluating a company's performance, including total assets, profitability (PROFIT), which is calculated by dividing net income by the difference between total assets and total debt It also highlights leverage (Lev) as the ratio of total debt to total assets and liquidity (Liquid) as the ratio of current assets to current liabilities Additionally, the analysis incorporates firm fixed effects (qi), time-fixed effects (tt), and clustered standard errors at the firm level (cit) to enhance the accuracy of the results.
CFV Calculated as the standard deviation of cash flow for every Refinitiv five years.
Pilot A dummy variable and equal to one when the ETS pilot Refinitiv has implemented in Guangdong, Shanghai, Tianjin, and Beijing from 2013; Hubei and Chongqing from 2014;
PB Price-to-book ratio measure as price close to book value Refinitiv
Firm Size Firm size by the natural logarithm of total assets Refinitiv
Firm Age Firm age by the natural logarithm of data year minus year Refinitiv established plus one.
Cash Ratio Cash and cash equivalents to total assets Refinitiv
Profit Profit scaled by the ratio of net income to the difference of Refinitiv total asset and total debt.
Leverage Leverage by total debts to total assets Refinitiv
Liquidity Liquidity by total current asset to total current liability Refinitiv
This study builds on existing literature concerning the impact of Emission Trading Systems (ETS) on financial factors, referencing works by Li et al (2022), Ni et al (2022), and Yu et al (2022) Utilizing a staggered Difference-in-Differences (DID) model, the research evaluates how the ETS pilot program affects firms' cash flow volatility (CFV).
The Difference-in-Differences (DID) method is a prevalent technique in applied microeconomics for identifying causal effects, especially during the implementation of policies or programs (Baker et al., 2022) A notable application of this method can be seen in the analysis of the Kyoto Protocol (Nguyen and Phan).
The Difference-in-Differences (DID) approach, as outlined in recent studies (Luu et al., 2023; Chen et al., 2022a), involves comparing the average outcomes of treatment groups with those of control groups before and after the intervention This method helps to effectively assess the impact of Universal Demand laws and Environmental Trading Systems (ETS) on various units.
The Difference-in-Differences (DID) approach is commonly used in observational studies where the assumption of exchangeability between treatment and control groups is not valid By relaxing the assumption that unobserved differences remain constant over time in the absence of treatment, the DID method effectively mitigates biases stemming from permanent differences between groups Additionally, it addresses biases resulting from external trends that may influence outcomes over time.
The study utilizes a staggered design, which is theoretically preferred over a traditional Difference-in-Differences (DID) design with a single treatment period (Baker, 2022) The parallel trends assumption is crucial for the validity of the DID approach, as a single treatment period may lead to confounding effects from contemporaneous trends unrelated to the policy or program In contrast, staggered DID designs enhance credibility and robustness by incorporating multiple treatment periods, thereby mitigating concerns about treatment effects being influenced by these trends (Athey and Imbens, 2018; Callaway and Sant’Anna, 2020) Consequently, the findings from staggered DID designs are deemed more reliable and trustworthy The model employed in this paper is specified as follows:
CFVint = œ + BPilot, + yControlS;c+ + Pi + Tụ + it
In this study, the dependent variable is the firm's Cash Flow Value (CFV), while the Pilot variable indicates whether a province has implemented the ETS pilot program, coded as one for the respective year Control variables include the Price-to-Book ratio (PB), Firm Size (FIRMSIZE), Firm Age (FIRMAGE), Cash Ratio (CASHRATIO), Profit (PROFIT), Leverage (LEV), and Liquidity (LIQUID) Additionally, the notation i represents the firm, p denotes the province, and t signifies the year.
Chapter 3 outlines the research methodology and key variables of the study, utilizing the Difference-in-Differences (DID) model to assess the impact of Emission Trading Systems (ETS) on Cash Flow Volatility (CFV) CFV is treated as the dependent variable, measured by the standard deviation of cash flow, while control variables include Firm Size, Firm Age, Price to Book Ratio, Profitability, Leverage, and Liquidity Data was gathered from Refinitiv, followed by pre-testing procedures such as data cleaning, rescaling, and coding into panel data format.
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This study explores the effects of Emissions Trading Systems (ETS) on cash flow volatility in high-emitting Chinese listed firms, analyzing a sample of 3,714 companies with 9,473 firm-year observations from 2010 to 2019 Utilizing a staggered Difference-in-Differences (DID) model alongside robustness, falsification, and dynamic timing tests, the research confirms the model's validity The findings indicate that ETS positively influences cash flow volatility by incentivizing investments in renewable energy and innovative technologies, which can foster long-term growth However, established firms with longer histories may exhibit greater resistance to risks associated with innovation investments, reflecting potential conflicts of interest between shareholders and managers as suggested by agency theory This research enhances the understanding of ETS implementation and its relationship with cash flow risk, emphasizing the critical role of investment decisions in green technologies on firms' financial stability and the potential for driving changes in environmental regulations.
This study highlights the critical need for increased focus on firms' cash flow, particularly during the challenging conditions imposed by the COVID-19 pandemic in China It explores the impact of Economic Transformation Strategies (ETS) on cash flow volatility, offering valuable insights into how these strategies influence financial performance in a time of social distancing and economic uncertainty.
The impact of Emission Trading Systems (ETS) on a firm's cash flow management is crucial for managers who depend on cash flow status for operational and strategic decisions While ETS can enhance performance by improving investment efficiency, it also introduces increased cash flow risk that managers must consider This volatility is significant, as managers tend to focus on immediate and tangible outcomes like revenue and profitability, potentially overlooking the longer-term implications of cash flow volatility associated with ETS.
The implementation of ETS can adversely affect a company's strategic planning and diminish stakeholder trust Therefore, it is crucial for managers to carefully observe how ETS influences cash flow volatility when considering increased engagement with it, and to utilize effective risk management strategies during their decision-making process.
To navigate future uncertainties and increasing compliance costs, firms are advised to increase their cash and cash equivalents while maintaining optimal cash holdings Research by Li et al (2022) indicates that higher cash reserves can mitigate the risk of excessive investments and provide liquidity for potential opportunities Companies may prefer cost-effective strategies, such as purchasing carbon emission quotas, over substantial investments in R&D for emission reductions The Emissions Trading System (ETS) incentivizes firms to optimize the use of current technologies and resources rather than making excessive capital expenditures.
The research highlights the importance of a managerial perspective on performance, emphasizing that while shareholder value often drives managerial strategies, it can obscure strategic clarity Managers must prioritize immediate cash flow outcomes due to their inherent uncertainty before addressing long-term goals This focus on strategic outcomes offers three key advantages: it reflects the management's strategic competency, provides timely feedback, and indicates cash flow volatility, which significantly influences other performance metrics, including the firm's risk of default and credit ratings.
2021) Therefore, to achieve more basic performance goals such as better default situations, firms must prioritize smoother income flows.
Policymakers and regulators can leverage this study to enhance financial markets by promoting rational resource allocation and addressing structural financing issues Implementing tax incentives and preferential loan terms for companies focused on long-term planning and stable income investments is crucial By prioritizing cash flow stability, companies can fulfill their financial obligations and make informed investment choices, ultimately fostering economic stability and resilience.
36 carefully consider the potential impacts of ETS on cash flow volatility and take appropriate measures to mitigate these risks.
Vietnam's initial plan for its Emissions Trading System (ETS) aims to include major polluters, with potential expansion to smaller entities later, aligning with global standards (World Bank, 2021) Implementing a carbon pricing mechanism not only enhances economic benefits but also mitigates climate change impacts While learning from China's ETS and low-carbon strategies is essential, Vietnam must adapt these lessons to its unique context Despite maintaining a growth rate of 2.5 to 3.5% annually over the past three decades, Vietnam's economy still has room for improvement (World Bank, 2023) To ensure sustained economic growth, Vietnam should diversify its economy, reduce export dependence, and invest in infrastructure, education, and research to foster innovation and attract foreign investment Streamlining regulations and enhancing transparency will create a more favorable business climate Companies should focus on stable, long-term investments and maintain optimal cash reserves to navigate volatility and compliance costs Tax incentives and favorable loan terms can further encourage long-term planning and stable income generation By addressing these critical areas, Vietnam can enhance its economic trajectory and improve citizens' quality of life.
5.3 Limitations and suggestions for further research
Despite the significant effort and dedication invested in the study, certain limitations persist One key limitation is the variety of methods available for measuring cash flow volatility; future research should consider exploring alternative measures and incorporating provincial control variables, as well as economic factors such as CO2 intensity and GDP per capita for a more thorough analysis Furthermore, it would be beneficial for future studies to examine the impact of environmental regulations, including Emission Trading Systems (ETS), on both firms' cash flow performance and their decision-making processes.
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