Preventing environmental disasters in investment under uncertainty

Peter Kort, Maria Lavrutich*, Claudia Nunes, Carlos Oliveira

*Corresponding author for this work

Research output: Contribution to journalArticleScientificpeer-review

Abstract

The paper considers a firm that has the option to invest in a project with an unknown profitability, which is affected by general market uncertainty. The project has the adverse effect that it can cause environmental damage. In case the firm has the option to undertake preventive investment at the time of market entry, we get that preventive investment is significant when (i) the project revenue is large, (ii) the environmental incidents potentially cause a huge reduction of firm value, and (iii) when preventive investment substantially decreases the probability of environmental damage occurrence. The optimality of such a preventive investment results in a significant delay of the project investment. When the firm has the possibility to invest in the project first and do the preventive investment later, this will accelerate the project investment and will result in a larger preventive investment when it indeed will decide to do that one later.
Original languageEnglish
Number of pages22
JournalEnvironmental & Resource Economics
DOIs
Publication statusE-pub ahead of print - Sep 2021

Keywords

  • Preventive investment
  • Real options
  • Environmental risk
  • CAPACITY CHOICE
  • OPTIONS
  • MODEL
  • POLLUTION

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