Many regulatory programs such as environemtnal regulation are effective only if firms make irreversible investments that reduce the cost of compliance. A firm potentially subject to regulation amy therefore behave strategically by not investing, thereby forcing the regulator to void the proposed regulation. We show that such incentives, which resemble a hold-up problem, may not be overcome when government's only tool is the imposition of an emissions tax. The hold-up problem can be overcome by the issuance of tradeable permits. A time-consistent equilibrium exists with all firms investing and the government imposing regulations, even if no permits are traded and their market price is low. Indeed, an observation of no trade may indicate that prollution abatement is great.
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