Adoption of green technology with financial friction

We investigate firms’ incentives to adopt green technology. To cover the adoption costs, a firm needs a bank loan. The bank cannot observe firms’ adoption costs and offers a loan contract that allows it to earn an intermediation margin. The Pigouvian tax leads to optimal abatement but inefficiently low adoption. The first-best outcome is achieved via a combination of environmental tax and loan subsidy. If the regulator is restricted to an environmental tax, it faces a trade-off between optimal adoption and optimal abatement. In this case, the second-best tax rate exceeds the Pigouvian tax rate. • Diffusion of green technology in a financially constrained industry. • A Pigouvian tax combined with a credit subsidy leads to the first-best outcome. • The second-best tax rate (tax-only policy) exceeds the marginal externality.