The role of managerial risk preferences on effectiveness of wind subsidies

Do risk preferences from wind project managers differentially determine the effectiveness of output-based and capital-based tax credits to wind investments? I address this question by developing and estimating a rational expectations equilibrium framework, disciplined to ERCOT plant-level microdata, that exploits this fundamental design difference between the Production Tax Credit (PTC) and the Investment Tax Credit (ITC). I show that the inherently riskier profile of output-based PTC benefits — tied to the stochastic future performance of wind output — induces project managers to invest more in wind capacity than under an alternative present-value-equivalent capital-based ITC subsidy (certain at the time of investment decisions). This occurs because output-based subsidies introduce greater uncertainty into the stream of investment cash flows — tied to the compensation payments of wind project managers — compared to their capital-based counterparts. As a result, managers over-invest (relative to the capital-based subsidy) as a form of self-insurance against this increased variance to limit potential compensation shortfalls that emerge from downside output risk over the decades-long investment horizons of wind projects. This mechanism renders output-based subsidies more effective at stimulating wind investments than present-value-equivalent capital-based tax credits.