Preventing Environmental Disasters in Investment under Uncertainty

Peter Kort, Maria Lavrutich (), Cláudia Nunes and Carlos Oliveira
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Maria Lavrutich: Norwegian University of Science and Technology
Cláudia Nunes: Instituto Superior Técnico
Carlos Oliveira: Universidade de Lisboa

Environmental & Resource Economics, 2022, vol. 83, issue 1, No 9, 199-220

Abstract: Abstract The paper considers a firm that has the option to invest in a project with an unknown profitability, which is affected by general market uncertainty. The project has the adverse effect that it can cause environmental damage. In case the firm has the option to undertake preventive investment at the time of market entry, we get that preventive investment is significant when (i) the project revenue is large, (ii) the environmental incidents potentially cause a huge reduction of firm value, and (iii) when preventive investment substantially decreases the probability of environmental damage occurrence. The optimality of such a preventive investment results in a significant delay of the project investment. When the firm has the possibility to invest in the project first and do the preventive investment later, this will accelerate the project investment and will result in a larger preventive investment when it indeed will decide to do that one later.

Keywords: Preventive investment; Real options; Environmental risk (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/s10640-021-00606-5

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