Agency conflicts and investment with carbon emission reduction

Abstract

We develop a dynamic investment model that incorporates agency conflicts, considering the impact of rare disaster and carbon emission reduction.} This model elucidates the effects of carbon emission reduction on capital investment, asset pricing, and welfare. Our findings indicate that optimal carbon emission reduction level increases with disaster risk, volatility, and risk aversion. Furthermore, in comparison to the inaction scenario, carbon emission reduction leads to underinvestment, enhances Tobin's $q$, increases risk-free rate, and decreases risk premium. This introduces a non-monotonic relationship among capital investment, risk-free rate, risk premium with disaster risk. Lastly, carbon emission reduction mitigates the cost for the outside shareholder to address agency conflicts.

Keywords: Capital investment, Agency conflicts, Carbon emission reduction, Rare disaster