How does internal carbon pricing affect corporate environmental performance?

Internal carbon pricing (ICP) has emerged as an increasingly popular tool for firms to cut emissions and combat climate change risks. We theorize the role of ICP by integrating legitimacy and stakeholder perspectives into dynamic capability theory. We argue that firms implement ICP to comply with stakeholders’ expectations, leading to corporate environmental strategic transformation which in turn improve a firm's dynamic capabilities. Furthermore, we argue that the heterogeneous nature of corporate motivation for such strategy transformation, reflected by carbon dependency and corporate climate target, moderates the relationship between the extent of ICP and the environmental outcomes. The Carbon Disclosure Project data of 500 U.S. publicly listed firms confirms that ICP reduces carbon emissions per employee and carbon emissions per revenue by 13.5% and 15.7%, respectively. Collectively, we advance understanding of corporate business strategy in the presence of climate change risks, posing both theoretical and practical policy implications.