# A Principal-Agent Model for Optimal Incentives in Renewable Investments

## TL;DR

This paper develops a model for optimal regulation of renewable investments, showing that regulating two firms separately with incentive mechanisms yields higher certainty and better emission outcomes than a single firm approach.

## Contribution

It introduces a novel principal-agent model for renewable energy regulation, demonstrating the benefits of separate firm regulation and cross-subsidies for green investments.

## Key findings

- Regulating two firms separately increases certainty in green investments.
- Optimal contracts involve time-dependent rebates for shutting down emissions.
- Numerical analysis shows improved outcomes compared to business-as-usual scenarios.

## Abstract

We investigate the optimal regulation of energy production in alignment with the long-term goals of the Paris Climate Agreement. We analyze the optimal regulatory incentives to foster the development of non-emissive 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.