Optimal dynamic contract with Knightian uncertainty of ESG rating

Abstract

In the context of “dual carbon” objectives, ESG investment concept has received wide attention. In this paper, based on stochastic systems and stakeholder theory, we analyze the interest requirements of subject stakeholders and investigate the agency conflict and coordination problems in the system. Combining with the contract theory, we construct a continuous-time principal-agent model with ambiguity aversion under ESG rating Knightian uncertainty. By the method of stochastic calculus in multiple priors, we derive the HJB equation for the optimal dynamic contract value function based on ESG rating Knightian uncertainty under incentive compatibility conditions. Then, for different ESG rating levels, through numerical simulation, we discuss the impact of the Knightian uncertainty degree of ESG rating on the optimal contract. The study shows that as the Knightian uncertainty degree of ESG rating increases, companies are more inclined to green development and the maximum expected return of principals decreases.

Keywords:

• ESG rating
• principal-agent model
• ambiguity
• dynamic programing principle
• Girsanov's theorem

Disclosure statement

No potential conflict of interest was reported by the author(s).

Data availability statement

Data sharing is not applicable to this article as no new data were created or analyzed in this study.

Additional information

Funding

The authors would also like to thank the National Natural Science Foundation of China (72301173, 62273003), the Research Project of Anhui Future Technology Research Institute (2023qyhz07).