2.1 The U.S. RGGI, a Market-based GHG Emission Policy
Among all other types of environmental regulations, ETS is the fastest growing. So far, around 80 jurisdictions worldwide employ 23 market-based systems, covering approximately 9% of global emissions (Luca et al., 2020). Except for the Korean ETS, all these policies are experimental. The EU-ETS, followed by the RGGI, California and Quebec cap-and-trade, and Chinese provincial ETS pilots (CN-ETS), are prominent and similar due to floor auction reserve prices. (Flachsland et al., 2020). Only the Quebec cap-and-trade has distinct features like reshaping and merging nature with other similar policies (ICAP., 2021). Unlike other ETS programs, Korea ETS (KETS) and New Zealand ETS (NZ ETS) are unique due to national coverage. The NZ ETS has a broader sectoral range, but revenues are assigned to the general budget without allotting for specific purposes (ICAP., 2020). In contrast, RGGI and CN-ETS covered only selected states and provinces, and EU-ETS was implemented in E.U. regions.
Primarily rein in CO2 emissions from the electric power industry, the single largest cumulative source of U.S. CO2 emissions for the last 40 years. In 2009, the U.S. RGGI became the first mandatory market-based regional regulation in the U.S. that relies only on auctions to allocate emissions permits. However, the RGGI has been operational in only ten northeastern states since January 2009, namely Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New York, Rhode Island, Vermont, and New Jersey. RGGI was explicitly introduced to reduce yearly CO2 emissions from the electric power industry by 45 percent below 2005 levels by 2020 and an additional 30% by 2030 in regulated jurisdictions (C2ES, 2019; RGGI Inc., 2020). Participating states met their target for CO2 emissions from fossil fuel consumption in the electric power sector by reducing them by more than 49% from 2005 levels in 2018 (EIA, 2021). Additionally, RGGI adjusts the cap on emissions of less than 21.9 Mt (million tons) annually across participating states. However, various factors contribute to this so-called emissions decline. It could occur due to reduced natural gas costs, decreased demand, or increased renewable capacity (Huang, L. & Zhou, 2019).[2]
The RGGI differs from the EU-ETS in that it has a fully functional auction, whereas the EU-ETS allows free grandfathering of allowances to former emitters (Borghesi & Montini, 2016; Haapala, 2017). RGGI has successfully conducted 50 auctions, selling 1.11 billion CO2 allowances for a total of $3.78 billion (RGGI Inc., 2020). The current CO2 emission cap was increased to 119.8 million tons from 96.2 million tons for the 11 participating states in 2021 (Virginia is participating for the first time). However, RGGI is continuously reducing the state-wise CO2 emission budget each year to reach 86.9 million tons by 2030 (RGGI Inc., 2020). The auction proceeds are distributed to member states for energy efficiency, renewable energy, direct energy bill assistance, agriculture and home technological innovation, and other GHG reduction programs (RGGI Inc., 2020). With over ten years of deployment, RGGI provides enough data for researchers to conduct an in-depth investigation of its emissions from the electricity sector (Chan & Morrow, 2019). In addition, RGGI significantly reduces spillover CO2 and SO2 emissions, resulting in significant societal benefits for both RGGI member states and neighboring non-member states (Chan & Morrow, 2019). RGGI has completed its three-year compliance phase in 2020 and reimbursed billions of dollars from emission budgets to consumers, primarily to assure low-carbon power generation. Thus, we assume that RGGI impacts firms' green innovation, ensuring energy efficiency and ultimately lowering CO2.
2.2 Green Innovation (GI)
Nearly a quarter-century has passed since Fussler and James (1996) initially defined green innovation as new goods and processes that add value to customers and businesses while having a negligible environmental impact. Some researchers have described green innovation as focused only on ecological considerations. For example, the primary objective of green innovation is not always to alleviate environmental burdens but to provide some environmental advantages (Driessen & Hillebrand, 2002). Likewise, Bernauer et al. (2007) and Dangelico and Pujari (2010) claimed that GI should comprise new or modified processes, practices, methods, and environmentally conscious products and contribute to product life-cycle sustainability.
Recently, authors added the economic success of a green innovation with an environmental benefit. For instance, GI refers to technology innovations in environmental management practices, pollution prevention, waste reduction, and energy-saving (Chen, Y. S., 2008; Zhang, J. M. et al., 2020). Lee, K. H. and Kim (2011) defined GI as integrating producer and supplier’s innovation efforts that enhance compliance with environmental regulatory requirements and achieve target economic success. In the extended literature, many authors aligned GI with multiple dimensions. For instance, Cai and Zhou (2014) argued that sharing knowledge of green design for new product expansion or production chain promotes a corporate green attitude. Therefore, sufficient attention must be paid to the function of knowledge management concerning environmental legislation and green innovation. Likewise, green design is an initiative carried out during the design and product development phase to lessen adverse environmental effects in the whole product life cycle (Tseng et al., 2013). Every firm has combined strategies for green innovation, which will optimize the firm’s revenue and environmental legitimacy (Wang et al., 2020). Practically, a business entity would not spend on activities that do not value the firm. Due to the high cost of inclusion, we feel that the firm's innovation must provide economic value for the organization. As a result, this research views GI as an activity that assists enterprises in promoting manufacturing, operating, and managing processes that result in economic gains and minimize environmental harm.
2.3 Nexus between Emissions Trading Schemes-RGGI and Firms’ Green Innovation
Despite the acceptability of ETS, researchers are also keen to investigate their effects ranging on various direct and spillover (indirect) issues related to environmental and economic issues. Scholars investigate ETS’s impact on ecological topics, including GHG emissions, carbon leakage, energy efficiency, and energy switching (from fossil fuel to low carbon), while R&D investment, financial performance, and market competitiveness lead to economic issues.
Several authors empirically investigated and identified reasons for reducing CO2 emissions in regulated states, especially after RGGI enactment. First, ‘electricity imports’ from neighboring states may result in CO2 emissions reductions within the regulated states (Lee, K. & Melstrom, 2018). Second, Kim and Kim (2016) established that the RGGI considerably accelerates coal to gas conversion. However, this reduction in emissions is primarily attributable to decreased coal inputs and emission leakage rather than 'coal-to-gas fuel switching' (Huang, L. & Zhou, 2019). Third, ‘energy-efficiency improvement’- RGGI raises retail electricity prices due to increased carbon costs, which reduces electricity demand (Rocha et al., 2015). However, energy-efficiency gains, not RGGI but energy-saving technology, were responsible for declining electricity demand (Narassimhan et al., 2018; Huang, L. & Zhou, 2019). Forth, shifting operational or production activities to non-RGGI states is also known as emission or generation leakage. Fifth, during the 'economic downturn,' energy efficiency stagnated due to a lack of government spending (Huber, 2013). Permit prices in auctions recorded very low after the immediate implementation of the RGGI, but the economy also faced a global financial crisis or economic downturn (Fell & Maniloff, 2018). Thus, economic fluctuations have a cohesive impact on demand for carbon allowances, leading to carbon prices (Luca et al., 2020). Sixth, other implemented policies, i.e., Renewable Portfolio Standard (RPS), could have influenced the dented CO2 emissions in the RGGI states (Johnson, 2014; Narassimhan et al., 2018). Finally, reducing CO2 emissions in RGGI participating states is not exclusively for the implementation of the RGGI but cohesive to direct or indirect factors.
Theoretical literature also argued that environmental policies increase firms’ innovation and bring long-term benefits (Porter & Van der Linde, 1995). Distinct E.R.s motivate firms’ environmental initiatives differently (Jaffe & Palmer, 1997; Kemp, 1997). Regulatory pressure creates innovative technological push (Lahteenmaki-Uutela et al., 2019) and market pull (Horbach et al., 2012), which forced to change the innovative activities to low-carbon technologies (Acemoglu et al., 2012). This push-pull pressure could help the firm to reduce environmental compliance costs and improve the ability to lessen ecological damages in the long run.
Recent studies show that market-based instruments influence FGI (Lyu et al., 2020; Ren, S. G. et al., 2020). The empirical literature confirms that introducing and implementing GI may bring technology innovation applied in green products or processes, persuade state-of-the-art environmental management, external knowledge adoption, energy-saving, cutting emission, and industrial output recycling (Yurdakul & Kazan, 2020; Zhang, J. M. et al., 2020). The RGGI is initiated to lessen emissions in the power sector through fuel switching high to low carbon, improve energy efficiency, promote renewable energy, and low-carbon technological development. According to WIPO’s IPC green inventory, firms filling applications for a patent with these attributes can be considered green patents. We used these green patents to measure a firm’s green innovation.
In this vein, proactive firms’ participation in GI helps meet the regulatory burdens, improve energy efficiency, and reduce waste (Li, D. et al., 2018). Market-based instruments are found to be efficient and effective in lowering harmful emissions. Still, whether this so-called decreasing emission could be sustainable without firms’ green innovation progress is yet to be explored. This sudden dented emissions trend may also happen for multiple reasons like diminished market demand, stakeholders’ pressure, and even macro-economic recession (Albort-Morant et al., 2016), (Woerdman & Nentjes, 2019). Besides, the legislative enforcement economic and social pressure are also driven to pursue sustainable growth FGI (Saunila et al., 2018), which help to improve the firm’s ecological performance (Guoyou et al., 2013). Besides the firm’s internal and external resources, market-based mechanisms also play a vital role in promoting FGI (Cai & Li, 2018). Therefore, a theoretical foundation assuring that market-based regulation has a significant relationship between an FGI.
The theory of innovation economics acknowledges that driving motives of firm-level GI are not fully encompassed by market and technology factors, but the regulatory aspects are needed for correction. Thus, ER has a dual effect by directly addressing the environmental externalities and, indirectly, encouraging FGI (regulatory push-pull hypothesis) (Rennings, 2000). The legislative push-pull can improve the firm’s resource efficiency, effectively controlling environmental hazards, encouraging FGI, and transforming the industry towards green innovation. In this point, we combined the narrow and weak version of Eco-efficiency theory with the “Porter hypothesis” framework that ER stimulates firms’ innovation and stringency of ER promotes innovation (Porter, 1991). Therefore, we construct a research question: "To what extent is the U.S. RGGI promoting the firm’s green innovation initiatives?" We focused on the U.S. RGGI instead of the only environmental regulations. We used FGI as a replacement for innovation initially considered in HP, extending HP and providing empirical evidence from the F500 companies like all other ETS.
[2] See more: (Ellerman & Montero, 1998)