Investment and Information Asymmetry in Corporate Sustainability: Incentives-Auditing Contracts and Policy

Speaker: Zhongli Wang  
Affiliation: Osaka University

Abstract

The integration of Environmental, Social, and Governance (ESG) criteria into investment strategies has reshaped corporate finance. This paper develops a real options model with incentive-auditing contracts to address principal-agent problems in ESG investments caused by information asymmetry. This contract model supports honest reporting by managers through designed incentives and auditing mechanisms as investment decisions are delegated to them. Additionally, we introduce a subsidy policy to assess its effects on contracts, and social welfare. Our findings reveal a paradox in optimal contracts where incentives inadvertently favor unsustainable projects, causing delays in sustainable investments due to information cost mitigation, thus conflicting with ESG principles. Results show enhanced corporate transparency leads to lower incentives, lower investment threshold for sustainable projects, and higher owners' option value but lower managers' Moderate transparency, counterintuitively, reduces social welfare due to escalating auditing costs, yet both very high and very low transparency levels correlate with improved social welfare outcomes. Subsidy policies enhance sustainable investment, particularly in low-transparency settings, and alter the impact of transparency on owners' option value.