Contracts for environmental goods and the role of monitoring for landowners willingness to accept

Transcription

1 Contracts for environmental goods and the role of monitoring for landowners willingness to accept Suzanne Elizabeth Vedel, Jette Bredahl Jacobsen and Bo Jellesmark Thorsen Forest & Landscape, University of Copenhagen, Rolighedsvej 23, DK-1958 Frederiksberg C, Denmark. Abstract Public procurement of environmental goods through the offering of menus of contracts available for private land owners is a standard policy measure. The contracting exercise typically embeds the usual agency issues of asymmetric information and moral hazard. A common measure to counteract the latter is the use of monitoring and control, perhaps on random samples of contracts. While the achieving the proper balance between costly monitoring and costly non-compliance has often been studied, we focus on the monitoring costs from the perspective of the agent and investigate how monitoring programs may affect the landowners willingness to accept a contract. We designed a Choice Experiment study, where landowners expressed their willingness to accept afforestation contracts with varying attributes, one of them being the likelihood of being monitored. Based on two strands of theories, we formulated a model allowing us to test two competing hypotheses regarding landowners reactions to monitoring as part of the contract. The first hypothesis is that landowners may plan deliberately not to comply with the terms, which would make monitoring increasingly unwelcome as the contract sum increases. The second hypothesis is that landowners plan to comply, and consider monitoring increasingly fair as the contract sum increases. Keywords: Afforestation, moral hazard, social preferences, self-image, choice experiment. Abbreviated edition of paper: Introduction Public procurement of environmental goods through the offering of menus of contracts available for private land owners is a standard policy measure in many countries, and is likely to grow along with the increasing focus on the potential of payment for environmental services (Wunder, 2007; Wunder et al 2008). Typically, such contracts specify a set of actions to be undertaken by the landowner, a target environmental change to be obtained, a payment to be made to the landowner and various other terms of the contract including e.g. length, procedures for the settlement of disputes, consequences in terms of non-compliance. From the view point of the buyer, e.g. an environmental agency, the contracting exercise embeds standard text book agency issues of asymmetric information and moral hazard (Salanié 2000), along with concerns about transaction costs and fixed costs (Anthon et al 2007a, b). Taking the typical agency point of view, a common measure to counteract the problem of noncompliance and moral hazard is the use of monitoring and control measures, perhaps in the form of monitoring random samples of contracts and landowners, in combination with reclaim procedure and possible sanctions when non-compliance is uncovered. Such monitoring is of course costly in it self, but while the issue of achieving the proper balance between costly monitoring and costly noncompliance has often been studied, we focus on the monitoring and control costs from the perspective of the agent and investigates how monitoring programs may affect the landowners willingness to accept a contract, when he or she evaluates this aspect along with other attributes of a contract.

2 Landowners may experience costs in more than one way in relation to monitoring. Clearly, direct costs occur to the landowner when monitored in the form of e.g. time spent on visits made by authorities, preparing documents and perhaps subsequent paper work. Another cost component could be related to the disutility the landowner may experience in relation to monitoring taking place e.g. due to a feeling of invasion of private property, seeing monitoring as an expression of mistrust, or simply fear of the power of bureaucracy. These latter issues relate to the dis-motivation that monitoring in it self may create. For a landowner to accept a given contract offered, any disutility caused by possible monitoring has to be compensated and thus raises the WTA. In addition to the above effects, a probability of being monitored may also affect the WTA in other ways. Pursuing the points of the principal-agent literature a bit further, the presence of high monitoring probabilities should increase the WTA of anyone planning not to comply with the contract terms and the higher a payment the contract offers, the larger is the problem of getting monitored. There are, however, competing theories regarding peoples, and also landowners, possible reaction and attitude towards the monitoring of contract compliance. While monitoring may of course reduce motivation if seen as a sign of mistrust in the individual, it may also be seen as positive, e.g. as a form of implicit valuation of the importance of the action undertaken (e.g. Frey and Jegen 2005) or as a chance of discussing management professionally. Apart from that, landowners may also hold social preferences (e.g. as in Nyborg 2000) that cause them to consider monitoring a fair and collectively responsible part of environmental contracts, and the higher payments are offered, the more monitoring may seem justified to these people. Based on these two strands of theory, we formulated a model allowing us to test two competing hypotheses regarding landowners reactions to monitoring as part of the contract. The first hypothesis is that the landowner may plan a priori deliberately not to comply with the terms, which would make monitoring increasingly unwelcome as the contract sum increases. The second hypothesis is that a priori he plans to comply, and considers monitoring increasingly fair as the contract sum increases, but still faces a risk of not being able to comply, e.g. due to hazards, or lack of experience in the field. We designed a Choice Experiment study (CE), where landowners expressed their willingness to accept afforestation contracts with varying attributes, one of them being the likelihood of being monitored. The hypotheses are tested in terms of the sign, size and significance of the interaction term of the contract sum and probability of being monitored. The environmental contract case we use for the CE is afforestation on agricultural land, which has long been an environmental contract activity in Denmark. The ecosystem services in demand are several, e.g. recreational aspects have been important close to cities (Anthon et al 2005), ground water protection in areas of high importance for drinking water utilities and biodiversity. Empirical evidence from the Danish authorities sample based monitoring of afforestation contracts shows that the degree of non-compliance is quite high and other countries have reported similar findings. These findings stress the relevance of our study as a basis for improving contract design to enable the selection among possible agents, those most likely to comply for given terms and providing a more varied picture of landowners preferences for monitoring. Discussion In the present paper we have investigated landowners stated preferences towards contracts for afforestation, and in particular focused on the issue of monitoring. This is of interest as it can inform policy makers and implementing authorities about landowners preferences for monitoring. Based on the literature on the role of monitoring for effort, we formulate two clear hypotheses as formalised and embedded in equation (1). The first hypothesis is that landowners plan noncompliance, which would be revealed by a negative parameter on the interaction term between

3 monitoring probability and subsidy offered. The second hypothesis is, that landowners overall find monitoring fair and reasonable and hold social preferences causing them to find monitoring increasingly more reasonable as subsidy increases. Support for this will require a positive parameter on that same interaction term. Overall result A general result is that landowners on the average require extra compensation for monitoring. However, for a significant part of the population, the higher the subsidy, the less compensation is required, indicating a degree of acceptance of monitoring the higher the subsidy. This offers support for the second of our hypotheses, and seems to strongly reject the first hypothesis for this group of landowners. This is supported by free text responses from landowners as summarised in Table 2. The RPL model for the whole sample shows that landowners have negative preferences for monitoring and require monetary compensation when monitoring by authorities is present in an afforestation contract. The required compensation increases with the percentage of landowners who risk receiving a monitoring visit by authorities. Moreover, based on the limited variation in the parameter for monitoring, landowners seem to be quite homogenous when it comes to the general requirement of compensation in relation to monitoring. The interaction term between monitoring and subsidy, which we use to investigate patterns of moral hazard and social preferences, is not significant in the RPL model for the entire sample. However, its standard deviation shows that there is a significant preference variation among landowners. Therefore landowners were grouped according to their stated attitudes towards monitoring in order to test if analyses of these splits potentially explain some of the differences in the population. The attitudes were identified by asking respondents, outside the choice sets, whether they would require compensation for monitoring. It was furthermore supported by written statements in the questionnaire where landowners were asked to state their attitude towards monitoring in an open-ended written statement. The literature related to moral hazard and agency theory as well as the literature on social preferences was reflected in these statements. 24.5% of landowners stated positive attitudes towards monitoring in these statements whereas 28.6% of landowners expressed negative attitudes towards monitoring. The remaining 55.9% of landowner did not answer the open-ended question except for a small fraction who stated that they were indifferent. Landowners with apparent social preferences The RPL analysis of landowners who had expressed positive attitudes towards monitoring showed a general disutility of monitoring similar to the whole sample. It also showed, however, a significant and positive interaction term of monitoring and subsidy. This means that landowners with a positive attitude towards monitoring show greater acceptance of monitoring when subsidy levels are high; implying that they reduce their demand for compensation for monitoring when subsidy levels increase. This confirms the hypothesis that some landowners, namely those with positive attitudes towards monitoring, also show social preferences and a greater acceptance for monitoring than landowners in general. Monitoring can be viewed as an external intervention and in other contexts this is known to affect people s intrinsic motivation positively or negatively if it is perceived as supportive or controlling, respectively (Frey, 1997; Frey and Jegen, 2005). This is reflected in landowners stated attitudes, where some landowners with positive attitudes perceive monitoring visits as a form of counselling and opportunity for a positive dialogue with professionals. Nearly all landowners with a positive attitude towards monitoring stated in a yes/no question that they would not require extra compensation for monitoring as such. This is in contrast to our model findings on the positive group, who in fact does require some compensation for monitoring. However, when we include both the negative effect of monitoring as well as the positive interaction effect of monitoring and subsidy, we find that the resulting requirement for compensation lies at the same level of approximately DKK 600 ( 80) when we look at the two extremes (1% monitoring and DKK 27,000;

4 25% monitoring and DKK 42,000). This may be related to the theoretical findings in Nyborg (2000) who argue that respondents may carry a dual set of preferences, one selfish and one civic. This is further extended by Brekke et al. (2003) who argue that there may be a divergence between people s stated choices and what they actually choose. Their actual choices may differ since they have to make a trade-off between the wish to act socially responsible and the desire to optimize individual utility. Although this is a purely stated preference study the answers to simple, direct questions may have a different effect on landowners than choices stated in the CE which may correspond more to actual choices. More specifically, the yes/no question to Would you require extra compensation if monitoring is present? may reflect more directly the ideals they have regarding their own person and how such a person is supposed to answer this question and thus appeal more to their social set of preferences. This can be set in contrast to the choices they make in the CE, which appeal more to their private set of preferences. Since the politically correct answer and social set of preferences is not as outspoken and clear in the choice sets as opposed to the yes/no question we may find that landowners to a higher extent also make the trade-off based on personal utility when they make their choices in the CE. In practice, the negative answer to extra compensation for monitoring may be a bit more based on self-image and social preferences and therefore slightly exaggerated (zero compensation) compared with the choices in the CE where the landowners to a higher extent include personal utility by being reminded of the context and other factors in the contract. Nevertheless, the conflict between the possible dual preferences is small here, as the required payment is fairly modest across the range of contract options. Landowners without apparent social preferences The analysis of the group of landowners, who stated more negative attitudes towards monitoring showed a general disutility of monitoring reflected in a demand for compensation although the significance is just beyond the 5% level (7.56%). The negative group seems to encompass a bit more variation than the positive group with relation to the interaction term between monitoring and subsidy. As opposed to the group of landowners with a positive attitude towards monitoring, we cannot reject that the parameter estimate for the interaction term is zero. Furthermore, based on the estimated standard deviation of preference heterogeneity in the population, we estimate that around 14% of landowners in this group in fact may have a negative parameter estimate for the cross effect. So even though the group as such does not show social preference or moral hazard, 14% of these are more averse to monitoring when subsidy levels are high, which could support the view discussed earlier on moral hazard and agents tendency to shirk. Thus, for this group we cannot reject the hypothesis that a non-trivial part of the population expects not to comply with the terms of the contract. We note that a large share of landowners with negative attitudes state that they perceive monitoring as controlling in a negative way and that they view it as mistrust from authorities. This is in accordance with the supportive or controlling view on monitoring found in the literature on motivation crowding (Frey and Jegen, 2005) and supports the view on social preferences discussed in this paper. Such perceptions may further enhance the alienation leading to higher moral hazard problems and noncompliance rates. Confirmation from a latent class model We also estimated a latent class model in order to see if latent segments of the sample also would involve different attitudes towards monitoring and the interaction term between monitoring and subsidy. And we did indeed find the same pattern as for the RPL model. The second of the latent classes had a significantly positive interaction term, and the class membership function showed that it was more likely for respondents with positive attitudes to belong to this class. The class constitutes 13% of the sample. Class three is also interesting as respondents there seem to care about all the attributes except the monitoring. Thus respondents in this group are cheap to monitor since they do not require extra compensation for monitoring and, moreover, they do not show premeditation to shirk.

5 Limitations of the study One of the strengths in this study is that we, by using stated preferences, are able to address landowners preferences and attitudes to specific environmental contract attributes before they enter a contract, and thus we can also elicit preferences for those who would not wish to enter a contract. It does however also impose a problem, and in particular for the analysis of monitoring related to moral hazard: would respondents really state if they intended to shirk? First of all, as the questionnaire was send out from a university it gives some sort of neutrality. Secondly, monitoring was only one attribute out of four and thus the setting may be so close-to-reality that shirking could be revealed. If it is in fact decided upon before entering a contract. If this is not the case, we would not be able to investigate intentions related to moral hazard at all with an ex ante study. Concluding remarks In the present study we have investigated the role of monitoring on landowners willingness to enter a contract for afforestation. Based on two strands of theory, that of agency theory and moral hazard and that of social preferences, we have formulated two competing hypothesis. Both of these reflect that landowners when entering a contractual relationship may consider positive and/or negative utility effects of monitoring. The first hypothesis is that landowners may plan not to comply and hence be subject to moral hazard issues. The second hypothesis is, that landowners overall hold social preferences causing them to appreciate monitoring, especially as public funds in the contract increase. We tested these hypotheses in models of Danish landowners preferences for afforestation contracts, which we elicited by the use of a choice experiment. We find that almost all respondents require some compensation for monitoring, even if they state a positive attitude towards monitoring. This is an important result as it raises the costs of monitoring for the agent to more than the direct costs. Overall, however, the analyses showed support for the hypothesis of social preferences among a significant group of landowners, who expressed a general positive view towards monitoring. For this group, we found that the higher the subsidy in the contract, the larger is the acceptance of monitoring, and the lower the WTA. Thus landowners may possess a dual set of preferences one related to the direct disutility of monitoring (e.g. in terms of time consumption, or feel of intrusion in the management) and one related to a social set of preferences a tendency to require efficient use of society s resources and thus also a higher acceptance of private loss if benefits are large. For the opposite group of landowners, who expressed a general negative attitude and suspicion towards monitoring, we did not find clear support for either of the hypotheses. This group does, however, require a higher direct compensation for monitoring than the positive group. However, the analyses also documented considerable preference heterogeneity in this group with respect to monitoring as subsidies in contracts increase. Thus, we cannot reject the hypothesis that for a nontrivial part of this group, moral hazard is a real risk already at the stage of contract evaluation.