Optimal management of durable pollution

We study an incompletely informed regulator's problem of inducing a firm producing durable pollution to manage its pollution optimally. We show the existence of an optimal regulatory contract. Our principal qualitative result is that the optimal contract in this setting induces an inefficiently large amount of emission, relative to the outcome under Pigovian regulation or full information. Our sparse, yet flexible, model of the firm can be applied directly in concrete settings as it is stated in terms of statistical parameters. Moreover, it generates useful information about the firm that has to be assumed in an abstract regulatory model.