Payments for environmental service contract design with asymmetric information
Date
2015
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Publisher
University of Delaware
Abstract
Payments for environmental service contracts commonly suffer asymmetric information problems before and after a contract is signed between a regulator and private parties. Before a contract, private parties possess private information such as productivity and production cost, and they may lie on their cost to get higher payments. After a contract, private parties may avoid fulfilling their responsibility. These problems need to be considered by the regulator when designing the contract since they are fiscally inefficient. This article proposes to involve monitoring choices in the contract design scheme as a signal of cost type and develops a principal-agent framework to study the interaction of the two problems. We established a dichotomous optimization problem to quantify the optimal payment schedule under different contract scenarios. We find that to design a feasible second-best contract, several conditions need to be met. Further analysis shows how the monitoring choices would affect the farmers' expected payoff and potential actions so that the regulator could direct the high-cost farms into the program with minimal or zero payment. We also find the interesting interaction between the hidden information and hidden action problem in a signal game which is a result of different signal levels. The significance of the signal would affect the distribution of the payment.