Green Capacity Investment Under Subsidy Withdrawal Risk

Abstract

This article studies the effect of different subsidy characteristics, like its size and withdrawal probability, on optimal investment timing and size. We find that increasing the risk of subsidy withdrawal, as well as increasing subsidy size, increases the firm's incentive to invest earlier but decreases the optimal investment size. We show that the optimal investment size is larger when no subsidy is implemented, although the firm will invest later then. A subsidy increases total welfare when subsidy withdrawal risk is very low or absent. If a policy maker aims at maximizing welfare, we show that the larger the subsidy withdrawal risk, the smaller the optimal subsidy is. When the policy maker aims to increase capacity, a subsidy is ineffective. However, a lump-sum tax can increase the firm's optimal capacity, at the cost of a delay in investment.