Irreversible Investment with Endogenous Scale under Kinked Subsidy Schedules

Luca Di Corato () and Dimitrios Zormpas
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Luca Di Corato: Ca’ Foscari University of Venice
Dimitrios Zormpas: University of Macedonia

No 2026: 07, Working Papers from Department of Economics, University of Venice "Ca' Foscari"

Abstract: We study an irreversible investment problem with endogenous scale under uncertainty, characterized by a concave subsidy schedule featuring a policy-induced kink. Using a real options framework, we analyze how the structure of policy support, in particular, the presence of threshold-induced kinks, reshapes optimal investment timing and scale. Motivated by the recent reform of the Common Agricultural Policy, which introduced redistributive payments linked to "first hectares", we show that nonsmooth support schemes fundamentally alter investment incentives. Smaller projects respond to higher subsidies by expanding investment scale without affecting timing, while larger projects exhibit non-monotonic responses: higher basic payments encourage expansion but delay investment, whereas stronger redistributive components induce earlier investment in smaller projects. These asymmetric responses generate a pooling effect around the policy threshold, whereby heterogeneous investors optimally converge to similar project sizes. By introducing policy-induced kinks into a real options model with endogenous scale, the analysis shows that redistributive subsidies can generate pooling and non-monotonic timing-scale responses that cannot arise under smooth or linear payoff structures. More generally, the results highlight how non-linear subsidies affect irreversible investment decisions, with implications for subsidy capitalization and the dynamic allocation of land.

Keywords: Real Options; Investment Timing and Scale; Non-Linear Subsidies; Land Development (search for similar items in EconPapers)
JEL-codes: C61 D81 G31 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2026
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