Policy Making for Regret-Averse Agents

Abstract Effective policy making for sustainable development requires understanding the behavioral drivers and reactions of adopting innovative sustainable practices and technologies of actors targeted by the policy interventions. When designing policy interventions, it is imperative to take behavioral biases into account. We analyzed how to design a policy that aims to foster the adoption of a sustainable technology by regret-averse decision makers. The sustainable technology, despite being socially welfare enhancing, involves a potentially large income loss in a bad-luck state that deters regret-averse decision makers from adopting it. Using a theoretical approach, we show that without a policy, a large income loss hinders the adoption of the sustainable technology by regret-averse decision makers. A policy that stabilizes the income streams of the adopters can induce regret-averse decision makers to adopt the sustainable technology. Regret aversion of the decision makers increases the cost of the policy. In addition, to induce the adopters to exert costly effort that might or might not result in generating an income, adopters should be compensated for their effort cost. The level of regret aversion, the probability of the bad-luck state happening, and the probability of an adopter generating extra income when exerting extra effort determine the possible policy payments. We conclude that to have regret-averse decision makers adopt a sustainable technology requires a different policy than for economically rational decision makers. Our findings contribute to understanding how to induce regret-averse decision makers to adopt innovative sustainable technologies and how to consider regret aversion in sustainability policies.