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Real Options Conference 2022

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Caps and quotas, taxes and subsidies, and runs following foreseeable policy changes

In competitive industries, foreseeable policy changes lead to inevitable runs which increase the volatility of investment. We show that this phenomenon, well-known in the case of caps and quotas, also applies to taxes and subsidies, and occurs whether policy changes apply only to new entrants or to all firms equally. Looking at the case of raising taxes (or removing a subsidy) we find that runs are smaller when the policy change affects all firms. We also find that the size of the run, i.e., the size of the resulting increase in market quantity is increasing in the magnitude of the tax raise. Finally, we show that during the run firms invest faster and more massively than on the socially optimal path, and therefore welfare decreases. We show that these results have implications for a broad range of policies, such as the removal of renewable energy subsidies in some European countries.

Yishay Maoz
Department of Management and Economics, The Open University of Israel

Richard Ruble
EM Lyon and GATE, CNRS


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