The Design of Voluntary Environmental Programs: Competition and Incentives to Participate

While Voluntary Environmental Programs (VEPs) have been widely used as a tool to reduce environmental damages in several contexts, incentives to participate have been a serious concern. The literature on VEPs shows that firms have an incentive to participate if participation is associated with an improved image, preemption of future regulation or emissions tax reductions. Otherwise participation incentives are limited. In this paper I show that, in the context of product markets, VEPs can be designed to create participation incentives. A VEP to expand production of a green product can offer participants a competitive advantage as it allows firms to credibly commit to a given output level. I consider a market where firms produce a differentiated product: a green and a brown version of a given product. The VEP requires participants to meet a target level of production of the green model that exceeds the free market level. The results show that participation incentives can exist in the absence of a regulatory threat or tax benefits, and that a tradeoff exists between the stringency of the target and the equilibrium level of participation. Under a mild target full participation in the VEP is a Nash equilibrium. However, a larger target results in less than full participation or no participation at all. Finally, while the VEP always increases competition between firms and increases market surplus, it may result in a higher level of environmental damages. Thus, the welfare implications of VEPs of this type should be carefully analyzed before they can be implemented.