Sustainable Investment Timing under Career Concerns, Agency, and Information

To provide an analytical explanation for delayed investments and low commitment to sustainability projects, we analyze a dynamic real option model where a manager (the agent) is responsible for the timing and scaling strategy of investment decisions. There are two types of projects available, one with lower investment costs but lower commitment to sustainability, i.e., lower scale (type I), and another with higher investment cost but higher sustainability commitment (type II). The owner (principal) employs the manager because he has an informational advantage about project costs and a specific reputation in the field of sustainability. A higher reputation increases the expected profitability of the project. However, the manager has career concerns and since he needs to publicly report on the sustainability progress, pressure on the manager increases as well, i.e., he will suffer reputational damage if the commitment to sustainability is not large enough. To design the optimal contract, the principal has to incorporate a potential reputation damage compensation into the contract in addition to incentives to disclose private information truthfully. We analyze the owner’s trade-off between the costs of the manager’s sustainability pressure due to early but low commitment (realization of type I) and lower payoffs in a later but potentially larger investment in sustainability (realization of type II). In contrast to existing literature, we find that higher managerial reputation leads to a strategy change in the type I project, delaying investment and increasing scale. We also show that the owner has to trade-off sustainability contracting costs against project financial performance when choosing a manager with a particular reputation.