Laszlo Sajtos ESSAYS O

N EN

VIRO

NM

ENTA

L REGU

LATIO

NS

ISBN 978-91-7731-171-3

DOCTORAL DISSERTATION IN FINANCE STOCKHOLM SCHOOL OF ECONOMICS, SWEDEN 2020

Laszlo Sajtos

ESSAYS ON ENVIRONMENTAL REGULATIONS

ESSAYS ON ENVIRONMENTAL REGULATIONS

This thesis consists of four papers in the intersection of environmental regu-lations and finance:

Paper I: Environmental taxation in Sweden

Paper II: The World’s Highest Carbon Tax

Paper III: The effect of carbon taxation on firm value- Evidence from Sweden

Paper IV: The reform of the EU ETS

LASZLO SAJTOS is a researcher at the Department of Finance at Stockholm School of Economics and the Swedish House of Finance. He holds a BSc in Physics from Eötvös Loránd University, Hungary, and an MSc in Actuarial and Financial Mathematics and Economics from Eötvös Loránd University and Corvinus University of Budapest, Hungary.

Laszlo Sajtos ESSAYS O

N EN

VIRO

NM

ENTA

L REGU

LATIO

NS

ISBN 978-91-7731-171-3

DOCTORAL DISSERTATION IN FINANCE STOCKHOLM SCHOOL OF ECONOMICS, SWEDEN 2020

Laszlo Sajtos

ESSAYS ON ENVIRONMENTAL REGULATIONS

ESSAYS ON ENVIRONMENTAL REGULATIONS

This thesis consists of four papers in the intersection of environmental regu-lations and finance:

Paper I: Environmental taxation in Sweden

Paper II: The World’s Highest Carbon Tax

Paper III: The effect of carbon taxation on firm value- Evidence from Sweden

Paper IV: The reform of the EU ETS

LASZLO SAJTOS is a researcher at the Department of Finance at Stockholm School of Economics and the Swedish House of Finance. He holds a BSc in Physics from Eötvös Loránd University, Hungary, and an MSc in Actuarial and Financial Mathematics and Economics from Eötvös Loránd University and Corvinus University of Budapest, Hungary.

Essays on Environmental Regulations

Laszlo Sajtos

Akademisk avhandling

som för avläggande av ekonomie doktorsexamen vid Handelshögskolan i Stockholm framläggs för offentlig granskning

tisdagen den 16 juni 2020, kl 10.15, Swedish House of Finance,

Drottninggatan 98, Stockholm

Essays on Environmental Regulations

Essays on Environmental Regulations

Laszlo Sajtos

Dissertation for the Degree of Doctor of Philosophy, Ph.D.,in FinanceStockholm School of Economics, 2020

Essays on Environmental Regulations© SSE and Laszlo Sajtos, 2020

ISBN 978-91-7731-171-3 (printed)ISBN 978-91-7731-172-0 (pdf)

This book was typeset by the author using LATEX.

Front cover photo:©Laszlo Sajtos

Printed by:BrandFactory, Gothenburg, 2020

Keywords:Climate Policy, Climate Change, Green Growth, Tax Policy, Competitiveness

iii

To my family and friends

Foreword

This volume is the result of a research project carried out at the Department of Fi-nance at the Stockholm School of Economics (SSE).

This volume is submitted as a doctor’s thesis at SSE. In keeping with the policiesof SSE, the author has been entirely free to conduct and present his research in themanner of his choosing as an expression of his own ideas.

SSE is grateful for the financial support provided by the Jan Wallander and TomHedelius Foundation, Stiftelsen Louis Fraenckels Stipendiefond and C.F. LiljevalchJr:s donationsfond, which have made it possible to fulfill the project.

Goran Lindqvist Per StrombergDirector of Research Professor and Head of the

Stockholm School of Economics Department of FinanceStockholm School of Economics

Acknowledgements

I would like to express my sincere gratitude to all the people who helped me reachthe final stage of my PhD journey, through either direct involvement or indirectsupport.

First, I am eternally grateful to my supervisors, Michael Halling and Per Stromberg.Michael became my mentor and guide to the academic world in the first half of theprogram when I set the goal to contribute to the asset pricing literature. He alwaysstood by me whenever I needed his support either in the form of a discussion on thepapers or a pep talk. His cheerful personality helped me see the sunshine throughthe clouds. Per became my mentor and co-author in the journey’s second half whenmy research interest turned to environmental regulations. I thank him for his time,funding, patience, and trust he placed in me, which made my PhD studies stimu-lating and productive. He became a role model for me as a teacher, researcher, andleader.

Second, I thank my co-authors Christian Thomann and Gustav Martinsson. Iam forever grateful to them for showing that research could be fun. I also learneda lot from them about how to present results, how to look for irregularities in thedata, and how to write a paper.

I am also indebted to my fellow PhD student colleagues with whom I couldshare the ups and downs. I am especially grateful to Alberto Allegrucci, AndreaLunghini, Berenice Ramirez Hart, Hendro Sugandi, Ivika Jager, Louise Jiaxin Wu,Yavor Kovachev, and Vasilis Dedes. I would like to thank the faculty and staff atthe Swedish House of Finance for providing a stimulating research environment. Iam grateful to Karol Vieker, Par M�artensson, and Thomas Lavelle for their excitinglessons in teaching, and to the Jan Wallander and Tom Hedelius Foundation as wellas Stiftelsen Louis Fraenckels Stipendiefond and C.F. Liljevalch Jr:s donationsfondfor their generous funding throughout the years.

My life would have been much less enjoyable without my great Hungarian friends.I have had a lot of fun together with Bence, Emese, Heni, Judit, Mark, Nori, Patrik,

viii

Peti, Viki in Stockholm, as well as with Andi, Dia, Emese, Erika, Tibi, Viki, andVivi in Hungary and Germany. They set a good example in terms of diligence, workethics, but they have also been a great source of inspiration for me. I am eternallygrateful to Mark for his terrible puns in Hungarian, English, and Swedish, and forhis patience when he edits my cover letters. I visited more than 20 countries withPeti Aleksziev where we experienced many, sometimes funny and sometimes scary,situations that we will never forget. Bence was the best teaching assistant I have everhad. He was one of my students in a course, but we became close friends and col-leagues by next year when we jointly graded 100 students’ exams and homework.His diligence, exceptional talent, and knowledge in finance made our collaborationa remarkable journey. I am grateful very much to Heni and Tibi for the pep talks,and for Babi and Janos who guided me on my first days in Stockholm.

Last but not least, I would like to thank my family for their unconditional loveand support I could enjoy in my entire life.

Stockholm, March 28, 2020

Laszlo Sajtos

Contents

Introduction 3

1 Environmental taxation in Sweden 51.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61.2 Environmental taxes . . . . . . . . . . . . . . . . . . . . . . . . . . 8

1.2.1 Theoretical background of environmental taxes . . . . . . . 81.2.2 Environmental policy in Sweden . . . . . . . . . . . . . . . 81.2.3 Energy taxes in Sweden . . . . . . . . . . . . . . . . . . . . 111.2.4 Combined tax payments . . . . . . . . . . . . . . . . . . . . 201.2.5 Other taxes in the transportation sector . . . . . . . . . . . 211.2.6 Taxes on pollution . . . . . . . . . . . . . . . . . . . . . . . 231.2.7 Tax on natural resources: gravel tax . . . . . . . . . . . . . . 24

1.3 Stakeholders’ sentiment . . . . . . . . . . . . . . . . . . . . . . . . . 241.4 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26Appendices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

Bibliography 59

2 The World’s Highest Carbon Tax 692.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 702.2 Data, measurement, and sample characteristics . . . . . . . . . . . . 74

2.2.1 Emissions data . . . . . . . . . . . . . . . . . . . . . . . . . 742.2.2 Firm and workplace level datasets . . . . . . . . . . . . . . . 742.2.3 The Swedish sample . . . . . . . . . . . . . . . . . . . . . . 752.2.4 International sample . . . . . . . . . . . . . . . . . . . . . . 76

2.3 Decomposing Sweden’s manufacturing CO2 emissions . . . . . . . 772.4 Evaluation of the world’s highest carbon tax . . . . . . . . . . . . . 792.5 The emissions intensity approach . . . . . . . . . . . . . . . . . . . 80

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x ESSAYS ON ENVIRONMENTAL REGULATIONS

2.5.1 Carbon intensity and the distribution of emissions across in-dustries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80

2.5.2 Profit margins and carbon tax payments . . . . . . . . . . . 822.6 The tax structure approach . . . . . . . . . . . . . . . . . . . . . . . 84

2.6.1 Different tax regimes . . . . . . . . . . . . . . . . . . . . . . 842.6.2 Firms divided into groups based on marginal tax status in 1993 862.6.3 Marginal tax changes and firm level carbon intensity . . . . 87

2.7 Global emissions and external validity . . . . . . . . . . . . . . . . 902.7.1 External validity: distribution of CO2 emissions across in-

dustries in the OECD . . . . . . . . . . . . . . . . . . . . . 912.7.2 Carbon intensity in OECD and Sweden over time . . . . . 92

2.8 Conclusions and implications . . . . . . . . . . . . . . . . . . . . . 932.8.1 Policy to combat climate change . . . . . . . . . . . . . . . 942.8.2 How to a structure a carbon tax . . . . . . . . . . . . . . . . 942.8.3 Technology adoption and development . . . . . . . . . . . 952.8.4 Carbon taxation and CO2 emissions reduction . . . . . . . 95

Appendices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

Bibliography 143

3 The effect of carbon taxation on firm value 1493.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1503.2 Hypothesis development . . . . . . . . . . . . . . . . . . . . . . . . 153

3.2.1 Tax announcement model . . . . . . . . . . . . . . . . . . . 1533.2.2 Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1533.2.3 Remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 156

3.3 Datasources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1573.3.1 Sample characteristics . . . . . . . . . . . . . . . . . . . . . 158

3.4 Research design . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1593.4.1 Event dates . . . . . . . . . . . . . . . . . . . . . . . . . . . 1593.4.2 Stock market reaction to the announcements . . . . . . . . 1613.4.3 Determinants of the investor reaction . . . . . . . . . . . . 1623.4.4 Outline of the empirical tests . . . . . . . . . . . . . . . . . 166

3.5 Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1673.6 Summary and conclusion . . . . . . . . . . . . . . . . . . . . . . . . 168Appendices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 170

CONTENTS xi

Bibliography 179

4 The reform of the EU ETS 1854.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1864.2 Literature review . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1924.3 The European Union Emissions Trading Scheme and its reforms . 193

4.3.1 Institutional settings . . . . . . . . . . . . . . . . . . . . . . 1934.3.2 Reforms of the system . . . . . . . . . . . . . . . . . . . . . 197

4.4 Hypothesis development . . . . . . . . . . . . . . . . . . . . . . . . 2004.5 Data, sample characteristics . . . . . . . . . . . . . . . . . . . . . . 204

4.5.1 Datasources . . . . . . . . . . . . . . . . . . . . . . . . . . . 2044.5.2 Sample selection . . . . . . . . . . . . . . . . . . . . . . . . 2044.5.3 Sample characteristics . . . . . . . . . . . . . . . . . . . . . 205

4.6 Research design . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2064.6.1 Stock market reaction to the announcements . . . . . . . . 2074.6.2 Determinants of the investor reaction . . . . . . . . . . . . 2114.6.3 Dynamic effects . . . . . . . . . . . . . . . . . . . . . . . . . 2154.6.4 Robustness exercises . . . . . . . . . . . . . . . . . . . . . . 216

4.7 Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2164.8 Summary and conclusion . . . . . . . . . . . . . . . . . . . . . . . . 219

4.8.1 Further research . . . . . . . . . . . . . . . . . . . . . . . . 220Appendices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 221

Bibliography 237

Introduction

Combating climate change and its consequences is a challenging and urgent task,which requires policy intervention as well as careful supporting research. However,contribution from the economics literature to solve this issue is still not sufficient(Oswald & Stern (2019)). The purpose of this dissertation is to continue filling thatgap with new empirical evidence. The thesis investigates corporate and investorsresponse to environmental regulations, and strives to draw lessons from past expe-rience.

The main laboratory setting is the Swedish green taxation system as its tax-onomy has several ideal properties for research (e.g. level, time series and cross-sectional variation, as well as available data). In addition, Swedish taxation (in partic-ular carbon tax) is regarded as a prominent example of how to tackle climate changewhile maintaining economic growth (e.g. Georgieva (October 8, 2019)). Under-standing its anatomy and impacts may help policymakers design environmental tax-ation systems elsewhere.

The primary purpose of the first paper, Environmental taxation in Sweden(joint work with Christian Thomann, Gustav Martinsson, and Per Stromberg), isto review the Swedish environmental regulation system from the 1980s to 2019. Wesummarize not only the different tax rates, but several other key aspects as well.The study also discusses changes in tax designs, key industrial pollution sources,and societal response to taxation in order to complement policy documents andhelp other researchers attempting to understand the Swedish system (see e.g. inAckva, Johannes and Hoppe, Janna (2018) and Energy & Environment (2018)).

The second chapter, The world’s highest carbon tax (ongoing work with Chris-tian Thomann, Gustav Martinsson, and Per Stromberg) aims to assess the distri-bution and impact of Swedish carbon tax on firm-level carbon dioxide emissionsand carbon intensity (i.e. emission over price adjusted output). We assembled acomprehensive dataset from firm-level accounting data as well as CO2 emissions inthe Swedish manufacturing sector in order to track firm-level carbon dioxide emis-

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2 ESSAYS ON ENVIRONMENTAL REGULATIONS

sions from 1990. Based on our novel database, we document that aggregate CO2-emissions decreased by about 13% between 1990 and 2008, while the Swedish man-ufacturing sector’s total output increased by 11% over the same period. We showthat about 40% of this decoupling can be explained by the Swedish manufacturingsector’s changing composition. In a more disaggregated analysis, we shed light onhow only a few sectors, and even a few firms within these sectors, account for thelion’s share of CO2 emissions and carbon tax payments. Firms in these industriesdisplay ten times higher CO2 emissions per unit of output compared to the leastcarbon-intensive sectors. And, carbon tax payments of the highest emitting firmswere almost 10% relative to EBIT. We also compute firm-year marginal carbon taxrates and document an inverse relationship between effective, marginal carbon taxrates and carbon intensity. Our study has a number of important implications forpolicy makers on how to mitigate the effects of climate change as well as for futuremacroeconomic and climate research.

The last two chapters focus on the investor side of environmental regulations.The third chapter, The effect of carbon taxation on firm value- Evidence fromSweden, investigates the effects of carbon tax on listed Swedish firms’ market value,and the underlying microeconomic channels that shape this linkage. The net im-pact on expected profitability hinges on the extra costs carbon taxation imposes onfirms, as well as the firms’ ability to raise revenues from the regulation (e.g. throughhigher costs or restricted entry for competitors). An event study methodology ex-ploits four announcements related to the increase of tax rates for industrial enter-prises. The results suggest a negative but weak valuation effect of carbon taxationon Swedish firms, which could be attributed to the generous exemptions granted toenergy-intensive industrial firms.

Swedish carbon taxation is not a standalone policy measure in the country asthe dominant instrument has been the emission trading system since 2011. TheEuropean Union’s main carbon pricing tool is one of the biggest emission-curbingattempts to date. However, previous trading phases did not provide high and ro-bust carbon prices (which is important to promote green investments). In order totighten the carbon market and restore carbon prices, the EU regulatory bodies laidthe trading system on new grounds. However, the potential economic effects of thenew policy are still debated. The fourth and last chapter, The reform of the EU ETS,aims to empirically evaluate the effect of the most recent structural reform of the Eu-ropean Union Emission Trading Scheme (EU ETS) on the regulated firms’ marketvalue and future expected profit. I also investigate the economic mechanisms that

CONTENTS 3

explain the upward-sloping price trend in permit prices that started after the finalvote on the reform package. Using event study methodology on a unique sampleof listed companies, I show that investors considered the new institutional settingsas a tightening of the carbon market, leading to statistically significant decline ofcumulative abnormal returns. The cross-sectional analyses suggest that stock pricereactions were concentrated among the most emission-intensive firms and in sectorswhere it is likely to be more difficult to pass costs on customers. However, the effectis considerably weaker for the latter sectors suggesting that the generous allocationof free allowances may alleviate investors’ concern regarding firms’ expected futureprofitability. The results also indicate that soaring permit prices after the final votemay stem from that carbon market participants started soaking up allowances ir-respective of their actual future needs, in anticipation of a further emission priceincrease. The findings suggest that the reform of the carbon market is consistentwith its expressed goals, but it may be necessary to investigate actors’ trading behav-ior and the weaker abatement incentives of sectors with elastic demand to providepersistent carbon price signal.

References

Energy, R., & Environment. (2018). Sweden energy and carbon tax policy.Retrieved from https://es.catapult.org.uk/wp-content/uploads/2018/10/

Sweden-Case-Study-FINAL.pdf

Georgieva, K. (October 8, 2019). Decelerating Growth Calls for Accelerating Action.Retrieved from https://www.imf.org/en/News/Articles/2019/10/03/

sp100819-AMs2019-Curtain-Raiser

Oswald, A. J., & Stern, N. (2019). Why does the economics of climate changematter so much, and why has the engagement of economists been so weak?Royal Economic Society Newsletter, October.

Ackva, Johannes and Hoppe, Janna. (2018). The carbon tax in Sweden. Retrievedfrom https://www.euki.de/wp-content/uploads/2018/09/

fact-sheet-carbontax-se.pdf