This paper studies the asset market for pollutive plants. Firms divest their most pollutive plants following environmental risk incidents. The buyers face weaker environmental pressures, and have supply chain relationships or joint ventures with the sellers. Following these divestitures, total and scaled pollution levels do not decline. The sellers earn higher returns when they sell more pollutive plants, and their ESG ratings increase while their regulatory compliance costs decrease after divesting. Overall, the asset market allows firms to redraw their boundaries in a manner perceived as environmentally friendly without real consequences for pollution levels and with substantial gains from trade.

We analyze jointly optimal carbon pricing and financial policies under financial constraints and endogenous climate-related transition and physical risks. The socially optimal emissions tax may be above or below a Pigouvian benchmark, depending on whether physical climate risks have a substantial impact on collateral values. We derive necessary conditions for emissions taxes alone to implement a constrained-efficient allocation, and show a cap-and-trade system or green subsidies may dominate emissions taxes because they can be designed to have a less adverse effect on financial constraints. Additionally introducing leverage regulation can be welfare-improving if environmental policies have a direct negative effect on financial constraints. Furthermore, our analysis highlights the positive effect of carbon price hedging markets on equilibrium environmental policies.

The control of carbon emissions by policymakers poses the new corporate challenge of developing an optimal carbon management policy. We provide a unified model that characterizes how firms should optimally manage emissions through production, green investment, and the trading of carbon credits, as well as the implications for asset prices. Under a carbon trading scheme, firms adopt precautionary policies such as under-producing compared to a laissez-faire benchmark. Perhaps surprisingly, firms with a large stock of credits are less committed to curbing emissions. Carbon regulation induces firms to tilt towards more immediate yet transient types of green investment as it becomes more costly to comply. Lastly, even if more polluting firms command a higher risk premium, carbon regulation need not reduce firm value.