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ABSTRACT:

Due to the irreversibility of many investments, firms often have a “rational reluctance” to invest immediately in risky projects and there is an option value to waiting. However, this delay in investment is sub-optimal if the technologies in question generate large positive externalities or reduce negative externalities. As pandemics and extreme weather events have shown, there is significant social value to early, pre-emptive investments. In this paper, I explore how a policy that reduces the uncertainty of future revenues brings breakthrough clean technologies to market. I develop a dynamic model of firm entry and investment which shows that a social planner prefers risk-reduction policies over Pigouvian subsidies if investment costs increase in price risk. I exploit the presence of bunching around the UK's renewable energy feed-in-tariff eligibility threshold to estimate the value of risk reduction to firms. The magnitude of excess bunching around the eligibility threshold confirms that firms significantly value risk-reduction, with the policy yielding a positive and significant impact on entry and investment into the renewable energy market. Policies to reduce investor risk may therefore be an important component of helping breakthrough technologies scale-up in a timely manner, which in turn can help avoid acute societal crises.

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