Asymmetric information and contract design for payments for environmental services

Abstract

In contractual relationships involving payments for environmental services, conservation buyers know less than landowners know about the costs of contractual compliance. Such asymmetric information reduces the effectiveness of payment schemes and increases the expense to implement them. To reduce these negative effects, conservation agents can take three approaches: (1) acquire information on observable landowner attributes that are correlated with compliance costs; (2) offer landowners a menu of screening contracts; and (3) allocate contracts through procurement auctions. Although current theory and empirical work provides practitioners with some insights into the relative merits of each approach, more theoretical work and experimentation in the field is necessary before definitive conclusions can be drawn.

Optimal Conservation Programs, Asymmetric Information and the Role of Fixed Costs

“…Over the past two decades, a sizable literature has emerged on incentive-compatible contracts as a tool to induce conservation (e.g., Smith 1995;Smith and Tomasi 1995;Moxey et al 1999;Babcock 1995, 1996;Ferraro 2008). This literature assumes that all conservation costs are variable in nature, and concludes that the complete-information (or first-best) solution is never incentive-compatible as farmers of the low-variable cost type have strong incentives to misrepresent themselves as high-variable cost farmers.…”

“…Despite the fact that these separating contracts can improve efficiency, they are hardly ever used in practice (Ferraro 2008). Two reasons may explain this lack of real-world application.…”

“…20 We have thus shown that F 1 > F 2 ≥ 0 is a necessary condition for the first-best solution to be incentive compatible, but condition (5) indicates that it is not a sufficient one. If F 1 > F 2 ≥ 0, the zero-cost isocost curves of the two types, k 1 (S, b) = 0 and k 2 (S, b) = 0, 18 Recall that the extant literature on payments for ecosystem services assumes that all conservation costs vary with the amount of services provided, and that it concludes that the first-best solution is never incentive compatible (see for example Smith 1995;Smith and Tomasi 1995;Moxey et al 1999;Wu and Babcock 1995, and Ferraro 2008. We replicate this result because F 1 ≤ F 2 encompasses the case where F 1 = F 2 = 0-the first best is never incentive compatible if all conservation costs vary with the amount of services provided.…”

“…Ferraro 2008). If the compensation payments are sufficiently generous, uniform (or one-size-fits-all) contracts can be very effective in inducing farmers to provide environmental services, but at the expense of generating substantial windfall profits.…”

Should We Pay for Ecosystem Service Outputs, Inputs or Both?

“…He then states that any advantage of one policy over another must " be due to inadequate information or uncertainty." This paper, along with the literature on procurement and contracting (Laffont and Tirole, 1993;Laffont and Martimort, 2002) has led to a number of papers applying mechanism design to agri-environmental polices (Wu andBabcock, 1996 andMoxey et al, 1999;Ferraro, 2008;Hanley et al, 2012 andMiteva et al, (2012).…”