Designing carbon contracts for difference under asymmetric information

Carbon contracts for difference (CCfDs) are agreements where governments support costly, low-carbon projects by compensating firms based on emissions reductions. However, asymmetric information makes it hard to design efficient contracts, as firms know more about costs than governments. This paper uses mechanism design to show that optimal compensation should be non-linear and concave in emissions reductions. Existing programs, such as those in the Netherlands and Germany, are typically linear. The analysis suggests these may be inefficient and proposes a menu of two-part tariffs for better performance.