Minimizing Costs, Maximizing Sustainability

Do strong incentives to cut costs lead firms to neglect negative externalities? We find that costcutting incentives can be environmentally friendly. To arrive at this conclusion, we examine uniquely detailed plant-level data of private and public firms in the most polluting industry in the US - electric utilities. To establish causality, we exploit the staggered passage of restructuring legislation, which opened the market to competition and incentivized utilities to cut costs. Following the restructuring, plants moved to cheaper but less polluting production processes. In addition, competition forces have improved allocation of operation across competing plants, contributing further to pollution reduction.