Subsidies for green technology adoption under uncertain demand and incomplete information

In order to encourage manufacturers to replace traditional high-emission equipment with new ones powered by green technology, alternative regulations, notably equipment subsidy policy (ESP) and operation subsidy policy (OSP), have been proposed to align manufacturers’ decisions with governments’ objectives. This study investigates manufacturers’ timing decisions to adopt green technology under ESP and OSP. In our study the market demand is dynamically stochastic, and the certain demand promotion is observable only by the manufacturer and can be promoted by inserting costly effort. A principal-agent model is developed in which the regulation on the adoption timing is specified as a call option exercised by the government and constrained by the manufacturer's incentive compatibility (IC), participation constraint (PC), ex ante IC, and ex ante PC. We find that the optimal subsidy policies exhibit stepwise structures, which depend solely on the demand promotion under complete information, and on the demand promotion as well as the manufacturer's effort cost under incomplete information. The optimal ESP and OSP are equivalent under complete information. Under incomplete information, these two policies lead to the same adoption timing if the demand is high, although ESP may require a larger subsidy budget. Otherwise, ESP promotes earlier adoption than OSP.