Environmental Externalities and Strategic (Un)Bundling in Complementary Goods Markets

Abstract

This paper studies how environmental externalities and asymmetric regulation shape bundling strategies in complementary goods markets. We develop a theoretical model of a two-good market in which an incumbent produces both a core product and its complement, while potential entrants supply only the complement. Production generates negative externalities addressed through Pigouvian taxation. Under symmetric regulation, the incumbent’s optimal strategy is mixed bundling, which coincides with the first-best outcome. The entry of low-cost competitors from jurisdictions with weaker environmental enforcement disrupts this equilibrium: by exploiting regulatory arbitrage, these entrants supply complements at relatively lower price that do not reflect their full environmental costs. In response, the incumbent is incentivised to unbundle fully and accommodate them, thereby reducing its domestic footprint while potentially increasing global damage. We show that such environmental unbundling can reflect either genuine progress or sophisticated greenwashing, depending on whether emissions are reduced or merely relocated. The analysis highlights how domestic environmental policy can create perverse incentives and points to border-adjusted carbon taxes as a corrective instrument to bring private incentives into closer alignment with social objectives.

Key words: bundling; environmental externalities; greenwashing; Pigouvian taxation.