Carbon Markets and Green Innovation: Path‐Dependent Firm Responses to Emissions Trading

ABSTRACT This paper identifies a dynamic boundary condition of the Porter hypothesis by examining how firms' pre‐existing innovation trajectories shape regulatory‐induced green innovation within the context of a market‐based carbon policy. Building on path dependency theory, we argue that firms' responses to environmental regulation are contingent on their prior, especially recent and continuous, green innovation trajectories, a previously overlooked capability‐based conditioning mechanism in the literature. Using China's CO 2 Emissions Trading System (ETS) as a quasi‐natural experiment, we find that regulatory‐induced green innovation is path conditioned: The ETS stimulates green innovation only among firms with recent green innovation experience but fails to induce green transitions among firms without green innovation experience or restart green innovation among firms with interrupted trajectories. Further analyses suggest that path dependence persists even after accounting for firms' total assets, industry technological intensity and regional government priority for innovation, factors often regarded as important drivers of regulation‐induced innovation. Our results thus reveal a specific, non‐monotonic and path‐dependent pattern of regulatory responsiveness that is not implied by standard resource‐based or induced‐innovation arguments: Not only the presence of past green innovation experience but also its recency and continuity influence whether firms can respond to environmental regulation through green innovation. This suggests that the effectiveness of this market‐based environmental policy in inducing green innovation is capability conditioned rather than universal across regulated firms.