The influence of carbon cost pass through on the link between carbon emission and corporate financial performance in the context of the European Union Emission Trading Scheme

Abstract In this study we examine, within the context of the European Union Emission Trading Scheme, whether firms' ability to pass through carbon costs affects the link between carbon emission and corporate financial performance. Our results, controlling for the endogenous relationship between carbon emission and financial performance, and robust to a number of alternative financial performance measures, demonstrate that good carbon emission performance does not always pay off. In fact, we find that lower levels of carbon emission are only rewarded if firms are not able to pass on carbon costs to consumers, either due to industry characteristics or firm‐specific carbon efficiency. Our results are in line with the view that as pollution is associated with increasing environmental costs, this negative impact of pollution on financial performance is mitigated for “carbon cost pass through” firms.