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Enforcement-proof contracts with moral hazard in precaution: ensuring 'permanence' in carbon sequestration

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  • Ian A. MacKenzie
  • Markus Ohndorf
  • Charles Palmer

Abstract

Opportunistic behaviour due to imperfect contract enforcement is a risk in many economic transactions. In this paper, an enforcement-proof incentive contract is developed in which a buyer demands a guaranteed delivery of a good or service given a productive upfront payment, moral hazard in precaution, and the potential for opportunistic contract breach. Investing in a contract upfront is found to be restricted by moral hazard and opportunistic contract breach. This limits the size of investment up to a specific level even if an infinite scale-up of production were beneficial. A more severe moral hazard problem results in a smaller distortion. The framework is applied and extended to international carbon sequestration contracts. In comparison to alternative liability attributions, the current regime of buyer liability yields inefficiently low levels of investment in carbon sequestration. Copyright 2012 Oxford University Press 2011 All rights reserved, Oxford University Press.

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Bibliographic Info

Article provided by Oxford University Press in its journal Oxford Economic Papers.

Volume (Year): 64 (2012)
Issue (Month): 2 (April)
Pages: 350-374

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Handle: RePEc:oup:oxecpp:v:64:y:2012:i:2:p:350-374

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Cited by:
  1. Stefanie Engel & Charles Palmer & Luca Taschini & Simon Urech, 2012. "Cost-effective payments for reducing emissions from deforestation under uncertainty," Grantham Research Institute on Climate Change and the Environment Working Papers, Grantham Research Institute on Climate Change and the Environment 72, Grantham Research Institute on Climate Change and the Environment.
  2. Bayer, Patrick & Marcoux, Christopher & Urpelainen, Johannes, 2013. "Leveraging private capital for climate mitigation: Evidence from the Clean Development Mechanism," Ecological Economics, Elsevier, Elsevier, vol. 96(C), pages 14-24.
  3. Suzi Kerr, 2012. "The Economics of International Policy Agreements to Reduce Emissions from Deforestation and Degradation," Working Papers, Motu Economic and Public Policy Research 12_12, Motu Economic and Public Policy Research.
  4. Blasch, Julia & Farsi, Mehdi, 2012. "Retail demand for voluntary carbon offsets – a choice experiment among Swiss consumers," MPRA Paper 41259, University Library of Munich, Germany.

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