Financial structure and the effectiveness of pollution control in an oligopolistic industry

This paper explores the link between pollution taxes and the financial and output decisions of firms in an oligopolistic industry facing demand uncert ainty. It is shown that environmental regulations such as pollution taxes m ay induce firms to alter their financial structure, which in turn influence s both output levels and the effectiveness of the tax in controlling pollut ion emissions. It is demonstrated that there exist circumstances in which h ighly leveraged firms may respond to pollution taxes by expanding output an d emission levels. This possibility arises in a leveraged oligopoly since t he tax acts as a credible commitment device which leads to more aggressive competition in output markets. (C) 2000 Elsevier Science B.V. All rights re served. JEL classification: D43; G33; H00; Q2.