Private investment with social benefits under uncertainty: the dark side of public financing

In this paper we first develop a theoretical model characterized by sequential activities and moral hazard. The game is an interaction between two agents: the first is in charge of the two tasks that imply a cost and an uncertain ex-post benefit (private agent); the second can decide whether or not to financially contribute on the two activities knowing that the size and the probability to attain a higher surplus ex-post depend on the first agent actions (public agent). In the second part we test our model through an experiment. On the one hand, the study confirms the main results of the model related to the most efficient type and timing of government contribution to the project. On the other hand, we discover that, even in the absence of a direct link between the public contribution and the second stage of the game, the private agent strategically decide to decrease the level of effort during the second period to penalize the public actor in the case of low contribution. This behavioral result has several policy implications. In fact, many investment in innovation or in climate change mitigation/adaptation are characterized by an initial investment and uncertain outcomes that depend on the management/development stage. With our study we demonstrate that a public contribution to finance the investment is not sufficient, and it can also be detrimental for what concerns the management stage and as a consequence the probability of success.