Mergers between Green and Brown Firms under Incomplete Information(1/2)

This research considers merger incentives of green and brown firms under cost asymmetry, product differentiation, and asymmetric information. We assume that the regulator has incomplete information on pollution intensity and associated social cost, and this article identifies the regulator's emission fees on the more polluting brown firms and production subsidies on the less polluting green firms, which provide incentives for differentiated firms to merge, reallocate output, and reduce pollution that is beneficial to consumers, producers, and the society as a whole. We first identify, as a benchmark, the regulator's optimal policy under complete information (the "first-best" policy), and compare it with the regulator's policy under incomplete information (the "second-best" policy), which forms a basis for the evaluation of social welfare under different information contexts. Specifically, when the regulator overestimates firms' pollution intensity, firms are subject to excessive emission fees that induce their mergers with and output shifts to the least polluting firm. However, when the regulator underestimates firms' pollution intensity, firms are subject to suboptimal emission fees that ameliorate their incentives to merge with less polluting rivals. This highlights the offsetting effects of mergers of differentiated firms on social welfare, which, on the one hand, increases market concentration, but on the other hand, reduces pollution. Our analysis show that environmental regulation may hinder welfare when excessive emission fees induce mergers that reduce market competition and completely offset the positive effects of pollution reduction on welfare. A similar argument applies when the regulator sets low emission fees and brown firms have no incentives to merge with and adopt the production technology of green firms to mitigate pollution. Accordingly, the results suggest that laissez-faire policy may be preferred to environmental regulation when the regulator has imprecise information on pollution intensity and the distribution of pollution intensity is volatile.