Khóa luận tốt nghiệp Tài chính ngân hàng: Does carbon pricing policy affect firms' investment decisions? The case of China’s emission trading schemes

This study uses a quasi-natural experiment with the Difference-in-Differences DiDmethod to examine the impact of the Chinese Emissions Trading Schemes ETS pilot on the capital investment

VIETNAM NATIONAL UNIVERSITY UNIVERSITY OF ECONOMICS AND BUSINESS

GRADUATION THESIS

DOES CARBON PRICING POLICY AFFECT FIRMS'

INVESTMENT DECISIONS? THE CASE OF CHINA'S EMISSION

TRADING SCHEMES

Supervisor : MSc Luu Hanh Nguyen

Student : Nguyen Thi Tra My - 19050699

Class : QH2019E TCNH CLC2

Hanoi, 2023

TABLE OF CONTENTS

Acknowlegdement 4

List of tables 5List of abbreviations 5

Abstract 6

CHAPTER 1: INTRODUCTION 7

1.1 Research Background 71.2 Research Objectives 91.3 Research Questions 91.4 Research Scopes 91.5 Research Methodology 101.6 Contribution of Research 101.7 Research Structure 11

CHAPTER 2: LITERATURE REVIEW 12

2.1 The theoretical framework for Emission Trading Schemes 12

2.1.1 Emission Trading Schemes 122.1.2 Conceptual background on Emission Trading Schemes 142.2 The relationship between environmental regulation and firms' behavior 162.3 The research gap 172.4 Hypothesis development 18

CHAPTER 3: RESEARCH METHODOLOGY 21

3.1 Data and Sample 213.2 Measurement of Main Variables 21

3.2.1 The dependent variable 213.2.2 The dummy variable 223.3.3 The control variables 223.3.4, The moderating variable 233.3 Empirical Model 23

CHAPTER 4: RESULTS AND DISCUSSION

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I would like to express my sincere gratitude to my supervisors MSc Luu Hanh Nguyen for her continuous support of my research, for their patience, encouragement,enthusiasm, and immense knowledge Her invaluable guidance has helped me in all thetime of researching , writing this thesis endless support during my studying period

I would like to express my gratefulness to all the lectures in the faculty of Financeand Banking, University of Econimics and Business, Vietnam National University whohave conveyed extremely valuable lessons for me during recent four years

Last but not least, I would like to thank all my family including my parents, myfriends Without their unconditional support and endless encouragement, I could hardlyfinish my graduation thesis

Student

Nguyen Thi Tra My

List of tables

Table 1: SUMMALY ¬rs is ẽẽ 25IE))I22200wi-r(9i10i ri 11 26Table 3: Baseline r€SuÏtS + 2x 1t HT TT TT CC HH TT TH HH 29Table 4: RODUStNESS t©SÉS - ST TY HH KH TH HH TT TT TH Hàn Hàn Tà Tàn LH 32Table 5: Dynamic timing t©SES các HH HH ng TH TT TH BH KH KH KH Hư nHrret 34Table 6: Placebo f@SS ch HH TH» HH HT HH HT TT TT TH TH KH KH KH KH HH ki 36Table 7: Economic mechainiiSIm - «<< << 2 1k ST TH TH KH KH KH HT HH HH 38

List of abbreviations

mm ——

This study uses a quasi-natural experiment with the Difference-in-Differences (DiD)method to examine the impact of the Chinese Emissions Trading Schemes (ETS) pilot on the capital investment decisions of over 3500 listed firms in China from 2010-2022 Theresults show that the pilot projects related to ETS have a positive relationship with thefirm's capital investment, providing evidence that ETS can be an effective way to increasefirms’ capital investment The study also found that the ETS had a positive effect on afirm's financial performance, with an increase in tangible assets, market capital, and cashflow from operating activities The robustness checks, placebo tests, and dynamic timingtests support the conclusion that the implementation of the ETS pilot could significantlypromote the firm's capital investment in China These findings have importantimplications for policymakers and business leaders seeking to promote sustainableinvestments and reduce carbon emissions However, further research may be needed toconfirm and extend the findings to other settings or industries

Key words: Emission Trading Schemes, China’s ETS, CAPEX, Capital Investment, DiD, Carbonpricing, Environmental Regulation, Sustainable Finance

CHAPTER 1: INTRODUCTION

1.1 Research Background

Climate change is indeed an alarming issue for the environment worldwide Itposes a significant threat to the Earth's ecosystems, including wildlife, plants, andhabitats, as well as to human societies and economies (Ren et al, 2020; Chen et al, 2021;

Yang et al, 2021; Ni et al, 2022) One of the most significant impacts of climate change is

the increase of greenhouse gas (GHG) in global temperatures (Yang et al, 2021; Liu et al,2022) GHG emissions come from a variety of human activities, such as burning fossil fuelsfor transportation and energy, deforestation, agriculture, and industrial processes Theseactivities release large amounts of carbon dioxide, methane, and other greenhouse gassesinto the atmosphere, which trap heat and contribute to global warming The effects of GHGemissions are significant and far-reaching (Liu et al, 2022) Climate change can cause sealevels to rise, more severe weather events such as hurricanes and droughts, and changes

in ecosystems and wildlife habitats It can also affect human health, by exacerbating airpollution and increasing the spread of diseases carried by insects and other vectors.Reducing GHG emissions is crucial to mitigating the impacts of climate change followed

by the Kyoto Protocol in 1997 This can be done by transitioning to cleaner energy sourcessuch as renewable energy, improving energy efficiency, reducing waste, and adoptingsustainable land use practices Governments, businesses, and individuals all have a role

to play in reducing GHG emissions and addressing the urgent need to address climatechange

To address the issue of climate change, it is essential to take action to reducegreenhouse gas emissions and promote the use of renewable energy sources Emissiontrading schemes (ETS) have emerged as a critical tool to mitigate the impacts of climatechange The first major ETS was established in 1995 in the United States to curb sulfurdioxide emissions that cause acid rain It showed that cap-and-trade systems could work

to reduce emissions at a lower cost In 1997, the Kyoto Protocol was adopted and allowedfor international emissions trading between countries Countries are enabled to buy orsell emission allowances to meet their treaty commitments The European Union ETS waslaunched in 2005 to help EU countries meet Kyoto targets After that, several countriesand regions respectively have established their own ETS, including New Zealand,California, China, and Korea, These systems have varying degrees of scope and

stringency but are also linked to generating greater emissions reductions and costefficiencies The ETS refers to systems that allow countries or companies to trade carboncredits or emissions allowances.

China is the world's largest carbon emission emitter (Nie et al., 2017; Yu et al.,2021) and accounts for approximately 28% of global carbon dioxide emissions (ChinaPower Project) In 2020, China policymakers announced that China would aim to reducethe target of peaking carbon emissions by 2030 and achieve carbon neutrality by 2060,which would require a significant reduction in greenhouse gas emissions follow by theNationally Determined Contribution of the Paris Agreement (Yu et al., 2021; Li et al, 2022;Liu et al, 2022; Ni et al, 2022) To achieve this goal, China has set targets for increasing theshare of renewable energy in its energy mix, improving energy efficiency, and reducingcoal consumption (Tan et al, 2022; Chen et al, 2022a) In addition, China has launchedseveral initiatives to promote green finance and support low-carbon development In

2011, China announced plans to launch carbon trading schemes in several regions as part

of its efforts to reduce greenhouse gas emissions The national ETS is an important steptowards achieving this goal and promoting sustainable development in China andglobally In 2013, four provinces including Beijing, Shanghai, Guangdong, Shenzhen andTianjin began to adopt the ETS pilot In 2014, Hubei and Chongqing implemented thispolicy In 2016, the ETS pilot was launched in Fujian The launch of ETS in China reflectsthe country's commitment to reducing its greenhouse gas emissions and addressing theglobal challenge of climate change and Sustainable Development Goals (SDGs)

Several studies have examined how the ETS pilot in China has affected firms'

performances The prior study found that firms that were allocated fewer emissionsallowances under the ETS pilot considerably enhanced firm environmental and economicperformance (Ren et al, 2022), improved the firm financing efficiency (Li et al, 2021),

increase firm’s cash holding (Li et al, 2022), significantly increases a firm’s cost of debt (Ni

et al, 2022), incentivize firm’s innovation (Ren et al, 2020; Ren et al, 2022), restraintsexcessive investment and encourages business investment efficiency (Chen et al, 2022a).Another study found that firms in the ETS pilot reduced output, cash flow and expectedincome (Chen et al, 2021), negatively affecting real earnings management ( Chen et al,2022b) Carbon trading policies have gained increasing attention in recent years as ameans to mitigate the impacts of climate change One question that has arisen is whethercarbon trading can incentivize firms to invest in low-carbon technologies and reduce

emissions This topic has explored the impact of environmental regulation on a firm'scapital investment through research on the Emissions Trading System pilot in China.

1.2 Research Objectives

The research objectives focused on key points First of all, the research summarizesprominent theories of emission trading schemes and firm capital investment Second, theresearch aims to investigate how the ETS pilot in China has influenced firms' decisions toinvest in capital and explore the potential benefits and challenges of ETS in promotingsustainable investments and reducing greenhouse gas emissions Third, the researchprovides insights into the effectiveness of this market-based mechanism in promotingsustainable investments and reducing greenhouse gas emissions The findings of the

research can inform policymakers, businesses, and investors about the potential benefitsand challenges of ETS, and guide the design and implementation of effective climatepolicies

1.3 Research Questions

This research considers how the implementation of ETS affects firms’ decisions toinvest in capital and what are the potential benefits and challenges of this market-basedmechanism in promoting sustainable investments and reducing greenhouse gasemissions This research question would involve examining the impact of ETS on firms'investment decisions, exploring the factors that influence firms’ decisions to invest in low-carbon technologies, and assessing the potential benefits and challenges of ETS inpromoting sustainable investments.

1.4 Research Scopes

The research collected data from over 3500 listed firms in 33 administrativedivisions in China from 2010 to 2022 in the Refinitiv database and chose eight Chinaprovinces that implemented the ETS pilot including Shenzhen, Guangdong, Shanghai,Beijing, and Tinajin from 2013, Chongqing and Hubei from 2014, Fujian from 2016 andfocused on the high carbon emission industrial consist industries, transportation, power,buildings and manufacturing followed by Ren et al, 2022; Chen et al, 2021; Yang et al,

2021

1.5 Research Methodology

Study the relationship between the emission trading schemes and the firm'scapital investment by using the staggered difference in difference model (DiD) withseveral tests including summary statistics, correlations matrix, baseline tests, robustnesstests and additional tests to examine the impact of the ETS pilot on corporate capitalinvestment behavior in China

The use of the DiD model provides a rigorous approach to estimating the causaleffect of the ETS pilot on capital investment decisions, while the various tests help to

ensure the validity and robustness of the results The summary statistics and correlationmatrix provide an overview of the data and identify any potential outliers or data qualityissues, while the baseline tests help to establish a baseline estimate of the treatment effect.The DiD method can address some of the challenges associated with traditional cross-sectional studies, such as omitted variable bias and endogeneity By comparing changes

in outcomes over time within groups, the DiD method can control for any time-invariantdifferences between the groups, such as unobserved characteristics or selection bias inthis study Besides, the robustness tests and additional tests provide further evidence tosupport the validity of the findings and address any potential concerns, such as selectionbias or omitted variable bias To recap, this study provides important insights into theimpact of environmental policies on firms' behavior and can inform policymakers andbusiness leaders seeking to promote sustainable investments and reduce carbon

emissions

1.6 Contribution of Research

This study adds several contributions to the literature Firstly, the studycontributes to the growing field of sustainable finance by providing insights into howfinancial instruments such as ETS can promote sustainable investments that benefit boththe environment and the economy This is a novel contribution to the literature as ithighlights the potential of ETS to promote sustainable investments and the benefits ofsuch investments Secondly, the study provides insights into how ETS can incentivizefirms to invest in low-carbon technologies and reduce their greenhouse gas emissions byshowing the potential impact of ETS on firms’ behavior and the potential for such policies

to drive positive environmental outcomes Moreover, the study identifies potentialbarriers that prevent firms from investing in low-carbon technologies, which can guide

policymakers and investors in developing strategies to address these barriers andsupport sustainable investment This is a valuable contribution as it highlights the

challenges and limitations of ETS, which can inform the design of effective climatepolicies To sum up, this study's contributions to the literature can enhance ourunderstanding of the potential benefits and challenges of carbon trading as a tool formitigating climate change and promoting sustainable development These findings canhave important implications for policymakers, investors, and firms seeking to promotesustainable investments and reduce carbon emissions

1.7 Research Structure

The structure of this research is organized as follows Chapter 1 reported theintroduction to the research Chapter 2 summarizes the literature on the impact ofenvironmental regulations on firms’ investment decisions Chapter 3 shows the research methodology Chapter 4 presents the empirical results analysis and further discusses the

findings Finally, chapter 5 concludes the study and offers policy implications

CHAPTER 2: LITERATURE REVIEW

2.1 The theoretical framework for Emission Trading Schemes

2.1.1 Emission Trading Schemes

Overview of Emission Trading Schemes

An Emission Trading Scheme (ETS), also known as a cap-and-trade system!(United States Environmental Protection Agency, 1980), is a market-based approach toreducing greenhouse gas emissions ETS works by setting a limit (or "cap") on the totalamount of greenhouse gas emissions that can be released within a certain time period andthen allowing companies to trade emission allowances amongst themselves Entities thatare subject to the cap can buy and sell these allowances on a carbon market If an entityreduces its emissions below its allocated allowance, it can sell its unused allowances toother entities that need them to comply with the cap This creates an incentive for entities

to reduce their emissions, as they can profit from selling any unused allowances, whilethose that cannot meet their emissions targets will need to purchase additionalallowances (European Union Emissions Trading System, 2004; California Cap-and-TradeProgram, 2015; Yu et al, 2022) Besides the cap and trade mechanism, the carbon tax isanother ETS mechanism The carbon emissions are set at a price for each tonne Entitiesthat emit carbon are required to pay a tax based on the amount of carbon they emit Thiscreates an incentive for entities to reduce their emissions, as they can reduce the amount

of tax they pay by reducing their emissions (Wang et al, 2023) In this topic, the authorfocuses on the ETS mechanisms.

The idea of using a cap-and-trade system to address greenhouse gas emissions wasfirst proposed in the early 1990s as a market-based alternative to traditional command-and-control regulations In 1997, The Kyoto Protocol, an international treaty signed,established cap-and-trade systems as a key mechanism for reducing greenhouse gasemissions Then, in 2005, The European Union Emissions Trading System (EU ETS) began,which is the world's largest cap-and-trade system and covers emissions fromapproximately 11,000 power plants and manufacturing facilities in 31 countries(European Commission) The success of the EU ETS and other similar systems in reducing

1 The concept of cap-and-trade originated in the United States in the 1980s as a way to address acid rain

caused by sulfur dioxide (SO2) emissions from coal-fired power plants The U.S Environmental Protection

Agency (EPA) established a cap-and-trade program for SO2 emissions in 1990, which was later expanded

to include nitrogen oxides (NOx) and other pollutants.

carbon emissions has made the ETS a practical method for reducing CO2 emissions fromindustries, making it a crucial tool for global climate change mitigation Other countries

and regions, such as California, Quebec, New Zealand, Switzerland, the United Kingdom,South Korea and China, have also implemented cap-and-trade systems to reducegreenhouse gas emissions So, the ETS is a practical method for reducing CO2 emissionsfrom the high industrial? emitter sector, acting as a global climate change mitigationvehicle

All in all, the widespread adoption of cap-and-trade systems highlights theimportance of market-based approaches in addressing climate change and reducinggreenhouse gas emissions The success of these systems in reducing emissions in various

countries and regions provides evidence of their effectiveness and potential for broaderimplementation in the future

Emission Trading Schemes in China

In October 2011, the National Development and Reform Commission (NDRC)issued a notice (No 2601 [2011] NDRC Climate Change Department) announcing theimplementation of a Carbon Emissions Trading Pilot Program in China The programdesignated Guangdong and Hubei provinces, as well as five municipalities, to participate

in the pilot program.

In 2013, China launched its first pilot emission trading scheme (ETS) in 2013 inthe city of Shenzhen, followed by ETSs in Beijing, Shanghai, Guangdong, Hubei, andTianjin Hubei and Chongqing adopted the pilot project in 2014 Two years later, Fujianlaunched the project in 2016.

These pilot schemes were designed to test the feasibility of a national ETS and togather experience in setting up and regulating carbon markets The nationwide ETS wouldbecome the world's largest carbon market in China and cover the power sector, initially

involving more than 2,000 power companies (ICAP, 2021) The scheme places a cap on

emissions from power generation and allows companies to buy and sell emissionallowances through a centralized trading platform China's ETS is seen as a significantdevelopment in global efforts to combat climate change, as China is the world's largestemitter of greenhouse gasses (Nie et al., 2017; Yu et al., 2021) The ETS is also part ofChina's broader commitment to reduce carbon emissions, including its pledge to reachpeak carbon emissions by 2030 and achieve carbon neutrality by 2060 However, there

? Follow the International Carbon Action Partnership, high industrial including power, transportation,

are also concerns about the effectiveness and transparency of China's ETS The initial cap

on emissions has been criticized for being too lenient, and there are concerns about theaccuracy and reliability of emissions data Additionally, there are concerns about thepotential for market manipulation and the lack of transparency in the allocation ofemission allowances Despite these challenges, the launch of China's national ETS is seen

as a significant step towards a more sustainable future.

By implementing an ETS, China can demonstrate its commitment to climate actionand contribute to global efforts to address climate change This can help to enhanceChina's standing in the international community and strengthen its relationships withother countries (Yu et al, 2021) In addition, ETS can incentivize companies to improve

their energy efficiency by reducing their carbon emissions, which can help to reduceChina's energy consumption and improve energy security (Mo et al, 20216) Moreover,ETS can help to reduce air pollution and other environmental impacts associated withhigh-carbon industries, which can have significant health benefits for the Chinesepopulation Last but not least, by putting a price on carbon emissions, ETS can encouragecompanies to invest in low-carbon technologies and practices, which can help China totransition to a more sustainable and less carbon-intensive economy (Ren et al, 2020) Inconclusion, the implementation of an ETS in China can bring multiple benefits, includingeconomic, environmental, and social benefits, and can help China to achieve its climategoals and contribute to global efforts to address climate change

2.1.2 Conceptual background on Emission Trading Schemes

In 1920, economist Pigouvian proposed a tax on the activity causing theexternality, such as a tax on carbon emissions, to incentivize firms to reduce theiremissions and internalize the cost of pollution The revenue from the tax could be used tocompensate those who suffer from pollution or to provide public goods that benefitsociety as a whole The Pigouvian tax has become an important concept in environmentaleconomics and has been applied to a wide range of policy issues related to pollutioncontrol and natural resource management Besides, this theory suggests that thegovernment should set a carbon price floor to ensure that the market achieves the desiredlevel of emissions reductions

In 1960, Coase's theorem argued that when property rights are well-defined andtransaction costs are low, individuals can negotiate and arrive at an efficient allocation ofresources without government intervention (Coase, 1960) When applied to ETS, this

theory suggests that the allocation of permits is not important for reducing emissions, aslong as the permits are tradable and firms can negotiate with each other to arrive at an

efficient outcome Coase's theorem has been influential in the development ofenvironmental economics and has been applied to a wide range of policy issues, includingpollution control and natural resource management

According to Porter's hypothesis (Porter, 1991; Porter and Linde, 1995),environmental regulations can spur innovation and cost savings for firms by encouragingthem to develop new technologies and processes that are more efficient andenvironmentally friendly This can lead to improved economic performance andenvironmental outcomes for firms This hypothesis challenges the common belief thatenvironmental regulations are a burden on businesses and instead argues that they canactually spur innovation and cost savings by encouraging firms to develop newtechnologies and processes that are more efficient and environmentally friendly Porter’shypothesis shows that firms that are able to adapt and innovate in response toenvironmental regulations can gain a competitive advantage over their rivals, leading toimproved economic performance and environmental outcomes Porter and Linde (1995)found that firms in the United States that invested in pollution abatement and preventiontechnologies experienced improvements in productivity and competitiveness Priorresearch has explored the relationship between environmental regulations, innovation,and competitiveness for firms (Jin et al, 2022; Lou et al, 2022; Ren et al, 2022) Otherstudies have found mixed results or even contradictory evidence, suggesting that therelationship between environmental regulations and innovation, and competitiveness iscomplex and context-dependent, such as (Chen et al, 2021) found that small and medium-sized firms may face greater challenges in complying with environmental regulations andinvesting in innovation than larger firms Overall, the Porter hypothesis still has been thesubject of much debate and research Nevertheless, the hypothesis remains a significantidea in the field of environmental economics and has influenced policy decisions andbusiness strategies around the world and contributed to the understanding of thepotential benefits and challenges of environmental regulations for firms, and hashighlighted the need for further research on this topic

Related to political economy, Ellerman (2010) has studied the design andimplementation of ETS in the European Union and argued that the success of ETS dependsnot only on its technical design but also on the political economy context in which it is

implemented Political economy considerations, such as the distributional effects of the

policy, the interests of different stakeholders, and the role of political institutions, can allinfluence the feasibility and effectiveness of ETS Moreover, the study has highlighted the

importance of building political support for ETS and addressing the concerns of industrygroups and other stakeholders in order to achieve long-term success

In summary, these theories highlight the importance of designing andimplementing ETS carefully to ensure that they achieve their intended goals of reducingemissions in a cost-effective and politically feasible manner

2.2 The relationship between environmental regulation and firms' behavior

Environmental regulation can have a significant impact on firms' behavior, as itcan affect their production processes, investment decisions, and overall competitiveness(Luo et al, 2022; Gao et al, 2021; Chen et al, 2022a; Chen et al, 2022c) The specificrelationship between environmental regulation and firms' behavior can depend on avariety of factors, including the nature of the regulation, the characteristics of theindustry, and the firm's own internal factors

In general, environmental regulation can lead firms to adopt moreenvironmentally friendly practices and technologies in order to comply with theregulations and avoid penalties (Gao et al, 2022; Ren et al, 2020; Ren et al, 2022) Thismay involve investing in pollution control technologies, reducing resource use, changingproduction processes to minimize emissions, or encouraging businesses to innovate inorder to increase their production and competitiveness (Chen et al, 2022c) Firms that areable to innovate and adapt to the regulatory environment may be able to gain acompetitive advantage over their peers (Luo et al, 2021) as they are better positioned tomeet the demands of environmentally conscious consumers and respond to futureregulatory changes Firms that successfully innovate and adapt to the regulatoryenvironment may gain a competitive advantage over their peers Additionally,environmental regulations can help reduce negative externalities associated withpollution and environmental degradation, leading to improved public health and well-being.

On the other hand, environmental regulation can also impose costs on firms, such

as compliance costs, monitoring costs, and potential penalties for non-compliance (Chen

et al, 2022b) In some cases, these costs may be passed on to consumers in the form ofhigher prices, which could reduce demand for the firm's products Firms that are unable

or unwilling to invest in environmentally friendly practices may face challenges in

complying with the regulations and may be at a competitive disadvantage relative to theirpeers (Ni et al, 2022) Besides, a phenomenon is known as the "compliance cost" effect,where environmental regulation can increase production costs for enterprises, leading toreduced investments in research and development (R&D) (Chen et al, 2021) In addition,after ETS of adoption, the firm has fewer opportunities for investment as well as greatercash holding (Li et al, 2022); which restrains investment (Chen et al, 2022a), reduces thecost of debt (Ni et al, 2022) and the policy effectiveness can difference in each treatmentregion (Zhou et al, 2020).

Generally, there is a complex relationship between environmental regulations andbusiness outcomes The specific impact of environmental regulation on firms’ behavior

will depend on a range of factors, and policymakers must carefully consider these factorswhen designing and implementing regulations The importance of considering thepotential costs and benefits of environmental regulation on firms when building policiescan promote sustainability and reduce carbon emissions Policymakers and businessleaders need to carefully weigh the potential impact of regulation on firms' behavior andcompetitiveness and consider the various factors that can influence the relationshipbetween environmental regulation and firms' behavior While environmental regulationcan incentivize firms to adopt more sustainable practices, it may also impose costs andchallenges that can affect their competitiveness and profitability

2.3 The research gap

The impact of emissions trading systems (ETS) on companies’ capital expenditure

is an important research that deserves more attention Capital expenditure (CAPEX)refers to the funds that a company invests in long-term assets, such as property, plant, andequipment, with the aim of generating future revenues (Karim et al, 2021; Ullad et al,2023) CAPEX is an important topic to study in the context of emission trading schemes(ETS) because it can have a significant impact on a company's emissions profile andcompliance with emissions regulations but is still under-explored in prior studies Under

an ETS, companies are required to hold a certain number of emissions permits, which can

be bought and sold on a market, followed by The U.S Environmental Protection Agency(EPA) in 1990 If a company's emissions exceed its permit allocation, it must purchaseadditional permits or face penalties CAPEX decisions can affect a company's emissionsprofile by determining the type of equipment and technology used in productionprocesses, which in turn can affect the amount of emissions generated Therefore, it is

important for policymakers, investors, and companies themselves to understand therelationship between CAPEX and emissions under an ETS By studying this relationship,

it is possible to identify opportunities for emissions reductions and to make informeddecisions about CAPEX investments that take into account both environmental andeconomic considerations

However, beyond green investments, an ETS may also significantly impactcompanies’ capital spending and investment strategies The future study can investigatewhether ETS leads to changes in companies’ total capital expenditure, investmentpriorities, and the types of new investments Next, companies with differentcharacteristics such as size, ownership, and industry, may respond differently to an ETS

in terms of capital investment Researchers can examine various firm-level factors thatpotentially shape companies’ investment behaviors under ETS to analyze theheterogeneity in companies' responses to ETS Since ETS frameworks can differsignificantly across countries, a comparative study of how companies change their capitalspending in response to ETS under different policy contexts may identify the mosteffective and investment-friendly policy designs The next studies can make internationalcomparisons of how companies react to different ETS designs In summary, futureresearch on how emissions trading systems affect corporate capital expenditure cananalyze companies’ green investments, total capital spending, heterogeneity, dynamics,international comparisons, and the role of policy stability Rich insights can be gained tohelp improve policy effectiveness, minimize adverse impacts on businesses, and achieveenvironmental goals at lower costs

The implementation of the ETS pilot typically imposes a cap on the number ofemissions that a firm can produce and requires the firm to purchase permits for any

emissions that exceed the cap (Yu et al, 2022) In order to comply with the emissions cap,firms may need to invest in new equipment and technologies to reduce their emissions.

These investments can be costly and may require a significant portion of the firm's capitalexpenditure budget (Yu et al, 2022) Additionally, firms may need to divert resourcesaway from other capital projects in order to finance the necessary emissions reductionmeasures Furthermore, the uncertainty surrounding the future price of emissionspermits in the ETS pilot can also have a negative impact on a firm's capital investment(Ren et al, 2020) If the price of permits is high, firms may need to allocate more resourcestoward purchasing permits, leaving less capital available for other projects

Hypothesis H1: The implementation ETS pilot may constraint the firm's capital investment

In some cases, an ETS pilot may actually incentivize firms to invest in new, moreefficient technologies, which could lead to long-term cost savings and improvedcompetitiveness (Ren et al, 2022, Luo et al, 2022) According to Porter's hypothesisEnvironmental regulations can stimulate innovation by creating new opportunities forenvironmentally friendly products and technologies, which can lead to cost savings andimproved competitiveness The firm may invest in renewable energy sources or developnew products that have a lower environmental impact and these investments can deem

to new revenue streams and improved competitiveness which can lead to improvedprofitability and sustainability in the long term (Lanoie et al, 2008)

The implementation of the ETS can create economic incentives for firms to invest

in emissions reduction measures, which can lead to cost savings, improvedcompetitiveness, and increased profitability in the long run (Zhou et al, 2020) Under anETS pilot, firms are required to purchase emissions permits to cover their emissions Ifafirm is able to reduce its emissions below the level of its allotted permits, it can sell theexcess permits on the market, generating additional revenue (Wen et al, 2021; Yu et al,2022) This creates a financial incentive for firms to invest in emissions reductionmeasures, such as energy-efficient equipment or renewable energy sources, which canlead to cost savings on energy and fuel Furthermore, the revenue generated from sellingexcess permits can be reinvested into the business, including towards capital projectswhich can enable firms to pursue new growth opportunities or make strategicinvestments in their operations (Zakeri et al, 2015) Additionally, an ETS pilot can create

a level playing field for firms, encouraging innovation and competition in emissions

reduction technologies Broadening the scope of the quota trading system, creatingstability in carbon pricing, and encouraging the management of carbon assets canenhance the effectiveness of financing within the carbon market (Li et al, 2021) and lead

to the development of new, more efficient technologies and that can further reduceemissions and improve the competitiveness of firms in the long run (Gao et al, 2020) Theimpact of an ETS pilot on a firm's capital investment can vary depending on the specificdetails of the ETS pilot, as well as the firm's size, industry, and overall financial position(Chen et al, 2021)

Hypothesis H2: The implementation ETS pilot can promote the firm's capital investment

To sum up, the relationship between environmental regulation and firms' capitalexpenditure is complex and can depend on a variety of factors, including the type andscope of the regulations, the industry in which the firm operates, and the firm's overallfinancial position This study will exploit the impact of the ETS pilot on capital investmentunder the firm's behavior aspects in China by using the staggered difference in differencemethod from a quasi-natural experiment

CHAPTER 3: RESEARCH METHODOLOGY

3.1 Data and Sample

The author collected firm-level data from the Refinitiv database between 2010 and

20223 The study focused on high-carbon emission industries, which were defined based

on information from the International Carbon Action Partnership (ICAP) and includedpower, transportation, buildings, industries, and manufacturing The study selected eightprovinces in China that applied the ETS pilot as the treated group, while non-pilotprovinces were used as the control group To ensure the accuracy of the data, the studywinsorized all continuous variables at the 1% and 99% levels to mitigate the potentialimpact of outliers The final sample included 3557 listed Chinese firms with 28,213 firm-

year observations for the period between 2010 and 2022 By focusing on these specificindustries and regions, the study aimed to investigate the impact of the ETS pilot on thefinancial performance of Chinese firms and to provide insights into the effectiveness of

ETS policies in reducing carbon emissions

3.2 Measurement of Main Variables

3.2.1 The dependent variableCapital expenditure (CAPEX) is the dependent variable in the study, it means thatthe study aims to investigate the relationship between the ETS pilot and capital

expenditure (CAPEX) spending by Chinese firms in the high-carbon emission industries

By analyzing the determinants of CAPEX spending, the study can provide insights into theinvestment decisions of Chinese firms in the context of emissions regulations andenvironmental policies The results of the study may be useful for policymakers andinvestors who are interested in understanding the impact of ETS policies on the financial

performance of firms and the broader economy

3 The study chooses the period from 2010 to 2020 in the Refinitiv database because it can allow the author

to control for various firm-level characteristics, such as size, industry, and financial performance, which can

affect the relationship between ETS and firm behavior to help ensure the validity and robustness of the

findings In addition, China's provinces have implemented the ETS pilot since 2013, so to limit the influence

of unobserved external shocks which can affect the study results Moreover, the author is concerned about

the impact of COVID-19 (Liu et al, 2022) on the relationship between ETS and the firm’s investment The final phase sample is from 2010 (before 3 years of adoption of ETS) to 2022 (after 3 years of the COVID-19 pandemic).

CAPEX is scaled by capital expenditure to total assets (Treepongkaruna et al, 2022;Azimli, 2022) By scaling CAPEX spending by total assets, the study can control for the size

of the firms and their investment capacity, which can affect their investment decisionsand behavior

3.2.2 The dummy variablePilot is a dummy variable and equal to one if the firm belongs to a given provinceand the year of implementing the ETS pilot Especially, five provinces Shenzhen, Shanghai,Beijing, and Tianjin adopted ETS from 2013; Hubei and Chongqing implemented ETS from2014; Fujian applied ETS from 2016

By including the Pilot variable in the analysis, the study can compare the CAPEX

spending of firms located in provinces with the ETS pilot to firms located in provinceswithout the pilot This allows the study to isolate the effect of the ETS pilot on CAPEXspending, which can provide important insights into the impact of ETS on firm investmentdecisions in high-carbon emission industries Overall, the use of the Pilot variable in thestudy is a crucial tool for identifying the causal effect of the ETS pilot on firm behavior andproviding more accurate estimates of the treatment effect

3.3.3 The control variablesThe study used regression analysis to estimate the effect of the ETS pilot on CAPEX

spending while controlling for other variables that could affect CAPEX, including FirmSize, Leverage, TobinQ, Tangible and Cash flow from Operating (Azimli, 2022; Ullah et al,2023), specifically: Firm Size scaled by the logarithm of total assets which can capture theeffect of firm size on CAPEX spending, as larger firms may have more resources to invest

in capital projects Leverage scaled by total debts to total assets, can report the effect offinancial leverage on CAPEX Tangible scaled by total tangible assets to total assets whichcan indicate the effect of asset structure on CAPEX spending, as firms with higher tangibleassets may have more capacity to invest in projects CFO measured by cash flow fromoperating to total assets, evaluates the effect of cash flow on CAPEX spending TobinQmeasured by market capital to total assets, as firms with higher market valuations may bemore likely to invest in capital projects

By controlling for these variables, the study can isolate the effect of the ETS pilot

on capital investment and provide more accurate estimates of the treatment effect Notonly this can help ensure the validity and robustness of the findings, but also it provides

important insights into the impact of ETS on firm investment decisions in high-carbonemission industries.

3.3.4, The moderating variable

RD is research and development expenses as a moderating variable that influencesthe strength or direction of the relationship between ETS and capital expenditure (Ren et

al, 2020; Chen et al, 2021) that can change the effect of one independent variable on thecapital expenditure depending on the level of the research and development

Specifically, the effect of ETS on CAPEX can be influenced by the level of researchand development expenses, as measured by RD (Gao et al, 2021) Depending on the level

of RD, the effect of ETS on CAPEX may be stronger or weaker, or may even change

direction By including RD as a moderating variable, the study can provide a more nuancedunderstanding of the relationship between ETS and CAPEX This can help identify theconditions under which ETS is more effective in promoting sustainable investments andreducing carbon emissions To summary, the use of RD as a moderating variable in thestudy can provide important insights into how the strength and direction of therelationship between ETS and CAPEX may vary depending on the level of research anddevelopment expenses

3.3 Empirical Model

In this study, the author uses a staggered difference-in-difference (DiD) model toevaluate the impact of the ETS pilot on corporate investment The model is specified asfollows:

CAPEXit+1 = a + BPilotit + yControlit+ (0 + T+ Eit+1

Where the CAPEX presents the firm’ investment and is measured by capitalexpenditure to total assets The Pilot refers to a dummy variable equal to one when theETS pilot has been implemented in Guangdong, Shenzhen, Shanghai, Tianjin, and Beijingfrom 2013; Hubei and Chongqing from 2014; Fujian from 2016 The control variables areFirm Size, Leverage, TobinQ, Tangible and Cash flow from Operating qj; is a fixed fixedeffect tris time-fixed effects

The research uses a quasi-natural experiment in which participants are notrandomly assigned to treatment groups, but rather naturally occur in groups based on