Incentives and moral hazard in agri-environmental policy

Agri-environmental programs have become popular in many countries as a means of improving environmental quality. In the United States, recent Farm Bills have progressively expanded the number and range of these programs beyond soil conservation to water quality and other issues. Economists have investigated problems in the design of efficient programs and have identified moral hazard (i.e., incomplete compliance with contractual requirements) as a major issue. Furthermore, it has been concluded that risks associated with farming and farmers' attitude to risk can have an important impact on the performance of programs.;Despite this, production decision making under multiple sources of risk/uncertainty and their impacts on compliance have received limited attention. In particular, interactions between various sources of risk and the impact of decision variables have been overlooked. In addition, although the role of compliance monitoring and penalties has been examined, little work has been done on the potential use of pecuniary rewards in agri-environmental policies. Consequently this study focuses on these issues.;The first essay addresses the question of how risk aversion affects the likelihood of compliance with agri-environmental programs when farmers face simultaneous monitoring, output price, and production uncertainty. The results indicate that risk aversion can mitigate the moral hazard problem in most cases, but if a conservation practice has a risk-increasing effect on production the impact of risk aversion on compliance is ambiguous.;The second essay explores the possibility for improving models to examine the impact of multiple sources of risk on firm decision making, taking account of interactions between sources. The impact of decision variables on these is also considered. The results show that ignoring interactions between major sources of uncertainty could result in misleading conclusions about firm decision making and for government policies designed to influence input use -- an aim of many agri-environmental policies.;The third essay uses a theoretical model and numerical analysis to examine the effect of a reward on the likelihood of compliance with agri-environmental programs under asymmetric information and output price uncertainty. The results suggest that when the costs of monitoring are very high and penalties for non-compliance are restricted (conditions applying to many existing programs), a reward can increase compliance rates with or without additional financial resources being made available. For risk-averse farmers, however, conditions that ensure a positive outcome become more restrictive.