ESG and Carbon Leakage: How Cap-and-Trade Regulations Influence Firms' Emission Allocation Strategies

Abstract

This study examines how firms respond to state-level climate regulation depending on their ESG status. Using facility-level emissions data and firm-level ESG indicators, I employ a difference-in-differences strategy that exploits California's cap and trade program. Difference-in-Difference estimation results show that regulated firms reduce emissions at California facilities but increase emissions elsewhere, and this leakage is concentrated among firms lacking ESG motivation. However, companies committed to ESG avoid domestic leakage but increase Scope 3 emissions, suggesting a shift to carbon-intensive activities abroad. These findings highlight the dual role of ESG: constraining carbon leakage domestically while potentially enabling global outsourcing. The study contributes to the literature on ESG governance and regulatory arbitrage and calls for stronger emissions accounting to prevent greenwashing and improve policy effectiveness under globalization.