Providing Certainty

Abstract

We introduce a moral hazard model in which public information about a payoff-relevant state arrives over time, an agent decides when to make an irreversible investment, and a principal commits to a state-contingent policy to incentivize investment. To discourage the agent from waiting for more information, the principal's optimal policy provides certainty, reducing the degree to which the agent's payoff depends on the state. This is inefficient -- both players would be better off with less certainty. We study when the agent receives positive rent, and when moral hazard delays investment. Our results apply to environmental subsidies and R&D incentives.