Optimal Timing of Environmental Policy under Asymmetric Information

Abstract

This paper examines the optimal timing strategy of environmental policy in the presence of agency conflict due to asymmetric information. When the policy maker delegates the adoption of environmental policy to agents, contracts must be designed to provide incentive for agents to truthfully reveal private information. Using a contingent claims approach, this paper shows that an underlying option value of social welfare can be decomposed into two components: a policy maker’s option and an agent’s option. The value of social welfare in the asymmetric information setting is strictly lower than that in the full-information setting. In particular, the implied adoption strategy in the asymmetric information setting differs significantly from that in the full-information setting.