Carbon markets and firms’ perceived climate regulatory risk

This study examines how involvement in emissions trading schemes (ETS) affects firm climate regulatory risks (FCRR) across 36 countries from 2003 to 2021. We find a positive link between ETS membership and FCRR. Furthermore, we investigate how governance structures and firm-specific factors influence this relationship. Our analysis indicates that factors such as financial constraints, CEO network size, CEO tenure, the number of independent directors, and board size can lessen the impact of ETS membership on FCRR. Conversely, higher corporate political risk, membership in carbon-intensive industries, and a greater number of co-opted board members intensify this effect. Early participation in the scheme appears to reduce the firms' climate regulatory risk, while subsequent withdrawal increases it. Notably, the influence of ETS on FCRR is mainly observed among firms operating in developed economies. Legislative shocks, such as the EU Climate and Energy Package, diminish the positive effect of the ETS on FCRR. Overall, our findings highlight the sensitivity of firm-level climate regulatory risk to strategic decisions regarding ETS participation and exit.