Mechanism Design for Allocation of Carbon Emission Reduction Units: A Study of Global Companies with Strategic Divisions and Partners

The problem addressed in this work is concerned with an important challenge faced by any green aware global company to keep its emissions within a prescribed cap. The specific problem is to allocate carbon reductions to its different divisions and supply chain partners in achieving a required target of reductions in its carbon reduction program. The problem becomes a challenging one since the divisions and supply chain partners, being autonomous, could exhibit strategic behavior. We model strategic behavior of the divisions and partners using a game theoretic approach leading to a mechanism design approach to solve this problem. While designing a mechanism for the emission reduction allocation problem, the key properties that need to be satisfied are dominant strategy incentive compatibility (DSIC), strict budget balance (SBB), and allocative efficiency (AE). Mechanism design theory has shown that it is not possible to achieve the above three properties simultaneously. We propose two solutions to the problem satisfying DSIC and AE: (1) a reverse auction protocol and (2) a forward auction protocol, while striving to keep the budget imbalance as low as possible. We compare the performance of the two protocols using a stylized, representative case study.