Environmental regulation and financial structure in an oligopoly supergame

This paper explores the link between an environmental regulatory instrument and the financial and output decisions of firms in an oligopolistic industry facing demand uncertainty. It is shown that environmental regulations such as pollution taxes may induce firms to alter their financial structure, which in turn influences both output levels and the effectiveness of the tax in controlling pollution emissions. It is demonstrated that in an infinitely repeated game the tax serves as a credible commitment device which facilitates collusion. Overall the results reveal that pollution taxes induce firms to hold more debt and lead to less competition in the product market.