Subsidizing uncertain investments: The role of production technology and imprecise learning

Abstract

This paper investigates the interplay between government subsidies, production technology, and learning through imprecise signals in shaping a firm’s investment strategy. Utilizing a real options framework with complementary investments, we address uncertainty in different investment stages and the limited informativeness of signals. Our findings reveal that optimal subsidization aligns a firm’s incentives with the evolving knowledge gained during the investment process. Specifically, the interaction between production technology elasticity and signal quality is crucial. Subsidies prove most effective when signals are highly informative, particularly when the technology’s returns are dependent on later-stage investments. This analysis highlights the need to manage uncertainty at each stage to maximize social net benefits, offering insights for policymakers on structuring subsidies under uncertainty.