A PRINCIPAL–AGENT MODEL FOR OPTIMAL INCENTIVES IN RENEWABLE INVESTMENTS

Ren㉠Aã D, Annika Kemper () and Nizar Touzi ()
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Ren㉠Aã D: Department of Economics, Université Paris-Dauphine — PSL Research University, UMR CNRS 8007-260, Paris, France2Africa Business School, Mohammed VI Polytechnic University (UM6P), Rabat, Morroco
Annika Kemper: Center for Mathematical Economics (IMW), Bielefeld University, Bielefeld, Germany
Nizar Touzi: Tandon School of Engineering, New York University, New York, USA

International Journal of Theoretical and Applied Finance (IJTAF), 2025, vol. 28, issue 01n02, 1-38

Abstract: In this paper, we investigate the optimal regulation of energy production in alignment with the long-term goals of the Paris Climate Agreement and analyze the optimal regulatory incentives to foster the development of nonemissive electricity generation when the demand for power is met either by a single firm or by two interacting agents. The regulator aims to encourage green investments to limit carbon emissions while simultaneously reducing the intermittency of total energy production. We find that the regulator can achieve a higher certainty equivalent by regulating two interacting firms, each investing in one technology, rather than a single firm managing both technologies. This higher value is achieved thanks to a greater degree of freedom in the incentive mechanisms, which involve cross-subsidies between firms. Moreover, we find that it is optimal to compensate firms for shutting down their emissive production assets. We provide closed-form expressions of the second-best contracts and show that they take a rebate form, involving time-dependent prices for each state variable. A numerical study quantifies the impact of the designed second-best contract in both market structures compared to the business-as-usual scenario.

Keywords: Principal–agent; optimal regulation; renewable energy (search for similar items in EconPapers)
Date: 2025
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DOI: 10.1142/S0219024925500049

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