Measuring Greenhouse Gas Emissions: What Are the Costs and Benefits?

Abstract

We adopt a financial-materiality approach in studying the costs and benefits of measuring greenhouse gas (GHG) emissions on social welfare. Production by firms internally generates direct GHG emissions (Scope 1 emissions) whereas outsourcing to suppliers generates indirect emissions (Scope 3 emissions). Our analysis incorporates two frictions: (1) long-term negative environmental externalities caused by emissions and (2) fragmentation in regulating emissions disclosures across jurisdictions. We show firms' failure to internalize the environmental externalities provides a rationale for mandating Scopes 1 and 3 emissions disclosures. However, such disclosures induce emissions leakage. Disciplining emissions leakage calls for setting complementary—rather than independent—disclosure requirements for Scopes 1 and 3 emissions. Our analysis underscores the importance of improving the reliability of Scope 3 emissions measurements given that measurements of Scope 1 emissions are highly reliable for public firms in Europe and the United States. Regulators can further enhance the disciplinary effects of Scope 3 emission measurements by requiring the allocations of Scope 3 emissions in supply chains to individual firms, especially when allocating Scope 3 emissions is more reliable, and for firms/industries that are more prone to transition climate risk relative to physical climate risk.