Optimal design of cross-compliance under asymmetric information

Abstract

The benefits of cross-compliance can be maximized only by taking into account the trade-off between economic costs due to cross-compliance prescriptions and environmental benefits produced. Both can, however, be strongly differentiated between different areas/farms. In addition, the effects of cross-compliance are conditioned by the ability to design appropriate incentives to compliance for farmers. The objective of this article is to develop a framework for the analysis of cross-compliance under asymmetric information when the differentiation of the compliance cost function is explicitly taken into account. This is accomplished by the development from the public regulator of a mathematical model of optimal cross-compliance design under asymmetric information about compliance. The methodology is applied to a case study represented by the municipality of Argenta in Emilia-Romagna Region (Italy). Empirical insights show the potential loss of net social benefits from cross-compliance when undifferentiated policies are implemented in cases with relevant differences in the value of costs of compliance. The analysis demonstrates that when the net social benefits of prescription have differentiated values, optimal policy design requires a differentiation of prescriptions and monitoring intensity. This is primarily addressed in this article through the consideration of differentiated compliance costs. However, the same would apply to provide appropriate incentives to farmers, taking into account differentiated environmental benefits produced and Single Farm Payment endowments.

Modelling the Linkages between Cross‐Compliance and Agri‐Environmental Schemes Under Asymmetric Information

“…A large body of literature treats the compliance with AES commitments in an asymmetric information framework, considering both the problem of moral hazard and adverse selection (see for example Choe and Fraser, 1999; Wu et al. , 2001; Fraser, 2002, 2009; Bartolini et al. , 2005, 2008; Hart and Latacz‐Lohmann, 2005; Raggi et al.…”

“…The same problems apply to some extent to CC, but the literature in this field is more limited. One of the few papers is Bartolini et al. (2008), who develop a principal‐agent model to analyse the problem of optimal policy design for CC.…”

“…This is first done through a mathematical model that is then used for a numerical application. This model is an extension of the model developed by Bartolini et al. (2008, 2011), which concerns CC, with inclusion of the choice to participate in the AES contract.…”

“…The expected profit when farmer i is only involved in SFP can be determined by the probability weighted sum of the profit when non‐compliance is not detected, and the profit when non‐compliance is detected (Bartolini et al. , 2008): …”

“…Following Bartolini et al. (2008) the first order condition (FOC) with respect to the optimal level of compliance is: which yields: …”