Pushing carbon footprint reduction along environment with carbon-reducing information asymmetry

Pushing carbon footprint reduction (CFR) by means of carbon regulation has received increasing attention. However, extant research primarily focuses on the design of carbon regulation under complete information, neither the feature of carbon regulation under asymmetric information nor the role of private information in the government-firm relationship has been explored. In this paper, we investigate the issue of government-firm contracting for CFR in the context of carbon-reducing information asymmetry. Two cases are considered: The single asymmetric information case where the firm’s carbon-reducing effort is privately known to himself, and the dual asymmetric information case in which neither the firm’s carbon-reducing capacity nor his effort is visible to the government. Carbon contracting model in each case is developed by mechanism design and game theory. To examine the effectiveness of these carbon contracts, the benchmark with complete information is further studied. Comparative statics and sensitive analysis show that the carbon contracts under information asymmetry can efficiently motivate the firm to reduce carbon footprint. In particular, under single asymmetric information, the government appropriately adjusts the optimal contractual configurations to maximize the expected welfare, leaving the firm to get the reservation profit. Under dual asymmetric information, the government’s best choice is to offer a menu of carbon contracts which enables the firm to obtain extra information rent that is increasing in his carbon-reducing capacity. We explicitly identify conditions under which the screening mechanism works and reveal that the menu of carbon contracts not only induces the firm to reveal his true carbon-reducing capacity but also motivates him to make the best effort to reduce carbon footprint. Our findings provide the government with a theoretical basis regarding carbon regulation under information asymmetry, as well as help firms make appropriate selections when signing low-carbon contracts with the government.