Permits as Real Options: Anticipation and Regulatory Leakage

We identify a new channel for regulatory leakage: the “permitting channel”. In many settings, permits lock in the regulatory regime at approval, allowing firms to acquire the option to invest under current rules. Unlike the conventional Green Paradox response, this channel operates without accelerating physical investment and pollution. We develop a framework in which firms can use real options to avoid anticipated regulation. We estimate the framework using Colorado’s oil and gas reforms, where permits surged before regulation but drilling did not. Policy-relevant designs that remove the permitting channel substantially reduce the health risks from pollution despite amplifying anticipatory investment.