Shareholders’ coalition for climate solutions: Is there a case for competition policy?

The investment required for the energy transition is very large. The market may provide too little investment (a market failure) because of two externalities: the environmental or climate externality and the technological spillover externality in abatement efforts in adopting green technology. Those externalities could be addressed in principle in competitive markets with carbon pricing and green subsidies. However, many markets are oligopolistic, and governments are constrained in the use of taxes and subsidies. Firm cooperation may come to rescue, and the question arises of what levels of cooperation should be allowed, and what role common ownership (with common investors in different firms in the same or different industries) can play. In the United States, congressional committees have questioned firm collaborations and coalitions to deal with climate change from an antitrust perspective. A comparative look at regulatory approaches reveals that the European Union, the United Kingdom, and other jurisdictions have adopted a more benign view of sustainability collaborations and climate coalitions in contrast to the US. These divergent approaches highlight the potential tension between promoting environmental objectives and preserving competitive market structures.

The paper reviews recent developments in competition policy in relation to environmental agreements in the US and Europe and examines its role drawing from the received knowledge from the Industrial Organization (IO) literature. An adaptation of the received IO innovation framework demonstrates that cooperative agreements and overlapping ownership can help incentivize a higher level of green innovation and net-zero commitments, mainly through the internalization of technological spillovers. Both firm size and common ownership are potentially key determinants of net-zero commitments and abatement efforts to reduce emissions. 

We know that the (first-best) welfare-optimal solution can be achieved in competitive markets equipped with optimal carbon pricing (equal to the social cost of carbon) and R&D subsidies that incentivize innovation without the need for firm cooperation or commitments. However, in practice, the reality of oligopolistic competition complicates this outcome. The incentives for firms to commit to green innovation and the welfare implications of those commitments depend on the degree of technological spillovers in R&D and the strategic nature of competition. R&D cooperation raises welfare when firms do not act strategically in their R&D choices (that is, when they do not try to influence market outcomes with their R&D investments) and there are positive spillovers. In those circumstances there is no need for an R&D subsidy in the presence of carbon pricing. R&D cooperation raises welfare when firms act strategically and there are high spillovers (lowering the green subsidy needed). 

When cooperation in R&D spills over into partial coordination in output, and spillovers are large, cooperative cost-reducing investments in R&D may increase (under reasonable demand specifications), but full product-market collusion remains socially undesirable, as the losses from reduced output and higher prices outweigh the gains from innovation. When spillovers are high, common ownership increases output, abatement effort, and welfare levels. The optimal welfare level of common ownership is positive for large enough spillovers. Moreover, it increases alongside the intensity of spillovers, the number of firms, the elasticity of demand, and of the innovation function. In certain conditions, even full cartelization may be optimal. 

Larger firms and coalitions are more likely to commit to decarbonization targets in the presence of carbon pricing. In an oligopoly where spillovers are high, firms' R&D commitments lead to underinvestment incentives and the need for larger levels of common ownership to improve welfare. In an oligopoly with a competitive fringe, commitments (to “overinvest” in green innovation) by large or a coalition of firms may be suitable substitutes for innovation subsidies. These commitments will incentivize smaller rivals to increase production and green investment, enhancing overall welfare. Therefore, there is substitutability between firm commitments and government carbon pricing: strong commitments by firms to decarbonize reduce the burden on public policy to incentivize the transition. 

Many questions remain to be answered. What is the optimal policy for regulating jointly carbon prices, green subsidies and the extent of common ownership? What role do green preferences play in the determination of optimal policy when environmental damages cannot be priced properly and/or green subsidies are limited?

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Xavier Vives is a Professor of Economics and Finance at IESE Business School and an ECGI Research Member. 

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