An increasing number of environmental protection programs offers financial compensation to farmers in exchange for conservation services. Incentive-compatible contracts can be designed to mitigate excess compensation, but the extant literature suggests that outcomes are always second-best so that other instruments (such as conservation auctions) may be preferred. We argue that the claim regarding the first-best solution never being incentive-compatible is correct if all conservation costs are variable in nature; if there are fixed costs too, the first-best compensation scheme may be incentive-compatible after all. Given the relevance of fixed costs in conservation issues, we conclude that incentive-compatible contracts should be given a second chance as a policy measure to induce conservation.
Keywords Asymmetric information · Payments for ecosystem services · Mechanism design
JEL ClassificationD82 · H23 · Q57We wish to thank two anonymous referees for their excellent comments, which helped us to substantially improve the paper's exposition and to sharpen the paper's policy implications. We would also like to thank Justin Dijk as well as participants at the 9th annual Bioecon conference for their comments and suggestions. Carmen Arguedas is grateful to the Spanish Ministry of Science and Innovation for their financial support (ECO2008-00510), and Daan van Soest wishes to acknowledge the financial support by "Knowledge for Climate" Program.