Environment, asset characteristics, and optimal effluent fees

This article investigates the issue of optimal effluent fees in a framework where waste emissions are abated by investing in capital of which the pay-off is uncertain and the cost is fully sunk. The stock of waste emissions harms an individual firm's production, but the firm will underestimate this external effect upon investing. Consequently, the firm will invest less capital, and thereby, pollute more than is socially desirable. The regulator, who can use effluent fees to correct this, should impose lower effluent fees on irreversible investments than on costlessly reversible ones when uncertainty arises.