A central claim in the literature on economic competition and environmental regulation is that governments are expected to respond to economic competition by lowering environmental standards. Governments do so over fear that firms move abroad in the face of stringent regulation. Recognizing that firms differ in how likely they are to relocate, this paper advances a political theory of regulating different types of firms in a globalized world economy. I argue that relative to domestic producers foreign firms’ relocation threats are more credible, resulting in more favorable regulation. Drawing on an original, installation-level data set, I find that foreign-owned installations in EU carbon markets receive more valuable permits for free. Additional tests and qualitative evidence underscore the plausibility of the proposed relocation mechanism. These results extend research on economic competition and environmental regulation beyond classical command-and-control regulation and highlight the importance of firm heterogeneity in international regulatory politics.