The Effectiveness of EU's Carbon Border Adjustment Mechanism (CBAM) and the Financial Impacts of CBAM on the Affected Firms: An Empirical Study

The EU’s CBAM is the first Carbon Border Adjustment Mechanism introduced in the world. By putting a fair price on the carbon emitted during the production of carbon-intensive goods that are entering the EU from non-EU countries, the CBAM aims to prevent EU producers from being put at a competitive disadvantage to imports from countries where carbon is not priced and, eventually, to encourage cleaner industrial production in non-EU countries. Therefore, we may say that the ultimate goal of CBAM is to promote corporations’ efforts in carbon reduction. CBAM was formally announced on July 14^th, 2021, and will apply in its definitive regime from 2026, while the transitional phase is from 2023 to 2025. Currently, six industries are subject to carbon border adjustment. According to the European Commission, this gradual introduction of the CBAM is aligned with the phase-out of the allocation of free allowances under the EU Emissions Trading System (ETS) to support the decarbonization of EU industry.

While the potentials of CBAM receive great attention from governments, practitioners, and scholars, there are also many criticisms and skepticisms about the effectiveness of CBAM. One major skepticism is whether CBAM can actually promote significant carbon reduction. Some also criticized that the increased cost of carbon reduction due to CBAM will burden the firms and, eventually, cause worse financial performance and higher resistance to the CBAM policy from affected firms or even countries. However, since CBAM will not be applied in its definite regime until 2026, there are few empirical studies that evaluate its effectiveness and impact. Therefore, the objective of this study is to empirically test the effectiveness of CBAM and the financial impacts of CABM on the affected firms.

The research design is based on the assumption that, since it takes significant time for corporations to effectively reduce their carbon footprint, corporations will invest efforts in carbon reduction and gradually exhibit lower carbon emissions well before 2026 if CBAM is going to be an effective mechanism or policy. We used the panel data from 2019 to 2022 to empirically analyze 144 firms that belong to those six industries that are subject to carbon border adjustment; 73 of them have been exporting to the EU (i.e., CBAM-affected) and 71 have not (non CBAM-affected).

In terms of policy effectiveness, based on theoretic reasoning and empirical studies concerning the effectiveness of carbon pricing in reducing carbon emissions, we hypothesize that CBAM is effective. Empirically, if CBAM is an effective policy, the degree of carbon reduction of the CBAM-affected corporations after the announcement of CBAM in 2021 will be higher than that of non-affected corporations. In terms of the CBAM’s impacts on firms’ financial performance, based on the increasing trend in green consumerism, we hypothesized that the increased sales of the CBAM-affected firms due to green production will outweigh the cost of carbon reduction, yielding better financial performance. Empirically, if the hypothesis is true, the financial performance improvement of the CBAM-affected corporations after the announcement of CBAM in 2021 will be higher than that of non-affected corporations.

The empirical results show that, while both CBAM-affected and non-affected firms exhibit “similar” level of carbon reduction before 2021, the year of announcing CBAM, the CBAM-affected firms exhibit “higher degree” of carbon reduction than the non-affected firms after the announcement of CBAM. Therefore, we conclude that the data supports that CBAM is an effective policy in terms of reducing the carbon emissions of the CBAM-affected firms. The results also show that, while both CBAM-affected and non-affected firms exhibit “similar” level of financial performance before 2021, the CBAM-affected firms exhibit “higher degree” of financial performance improvement than the non-affected firms after the announcement of CBAM. Thus, we may conclude that the data supports the idea that the increased sales of the CBAM-affected firms due to green production outweigh the cost of carbon reduction, yielding better financial performance.

To summarize, this study empirically shows that CBAM is very likely to be an effective policy and that firms’ cost of carbon reduction can be outweighed by the benefits of cleaner production. We suggest that, firstly, the CBAM-affected firms should begin as early as possible to invest in carbon reduction, and secondly, firms should be encouraged by the benefits of clean production to invest in carbon reduction.