Pollution Abatement Investment under Financial Frictions and Policy Uncertainty

This paper examines how financial frictions and policy uncertainty jointly influence firms' investments in pollution abatement. Our data analyses suggest that financially constrained firms are less likely to invest in pollution abatement and are more likely to release toxic pollutants, with this pattern intensified by policy uncertainty surrounding future environmental regulations, as measured by "close" gubernatorial elections or uncertainty revealed in firms' earnings conference calls. We then develop a general equilibrium model with heterogeneous firms, including both financially constrained and unconstrained firms, in which financially constrained firms face increased marginal costs of finance from pollution abatement. These costs are further amplified by policy uncertainty, reducing firms' incentives to prevent pollution. Therefore, the aggregate effect of environmental policies depends on the distribution of financial frictions and policy uncertainty