Investment and information asymmetry in corporate sustainability: Incentive-auditing contracts and policy insights

Zhongli Wang and Michi Nishihara

International Review of Financial Analysis, 2025, vol. 105, issue C

Abstract: This paper develops a real options model incorporating incentive-auditing contracts to address principal–agent challenges in ESG investments arising from information asymmetry. The model promotes honest reporting by managers through tailored incentives and auditing mechanisms, while also introducing a subsidy policy to evaluate its effects on contracts and social welfare. Our results reveal a paradox in optimal contracts: incentives may inadvertently favor unsustainable projects by mitigating information costs, thereby delaying sustainable investments. Enhanced corporate transparency is associated with reduced incentives, a lower investment threshold for sustainable projects, and an increased option value for owners but a decreased one for managers. Interestingly, moderate transparency reduces social welfare due to rising auditing costs, whereas both very high and very low transparency levels yield improved social welfare outcomes. Subsidy policies further bolster sustainable investment, especially in low-transparency settings, and modify the impact of transparency on owners’ option value.

Keywords: Sustainability; Information asymmetry; Agency problem; Real options; ESG investing (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:105:y:2025:i:c:s1057521925005228

DOI: 10.1016/j.irfa.2025.104435

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