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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 incomplete contract enforcement is a risk in many economic transactions such as forest carbon sequestration contracts. 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. The optimal design of forest carbon contracts to ensure permanence is derived. Buyer liability for loss of a carbon sink is shown to yield an ineficiently low level of sequestration. Yet it remains higher than the case where liability is neither allocated to the buyer nor the seller. Indexing contract prices to the seller’s opportunity costs potentially boosts the upfront investment as does shifting liability to the seller but not beyond first-best levels. Assigning liability is shown to have implications for forest carbon contracts in an international climate policy regime.

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Bibliographic Info

Paper provided by Grantham Research Institute on Climate Change and the Environment in its series Grantham Research Institute on Climate Change and the Environment Working Papers with number 27.

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Date of creation: Sep 2010
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Handle: RePEc:lsg:lsgwps:wp27

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Cited by:
  1. Suzi Kerr, 2012. "The Economics of International Policy Agreements to Reduce Emissions from Deforestation and Degradation," Working Papers 12_12, Motu Economic and Public Policy Research.
  2. Julia Blasch & Mehdi Farsi, 2012. "Retail demand for voluntary carbon offsets - A choice experiment among Swiss consumers," IED Working paper 12-18, IED Institute for Environmental Decisions, ETH Zurich.
  3. 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 72, Grantham Research Institute on Climate Change and the Environment.
  4. Bayer, Patrick & Marcoux, Christopher & Urpelainen, Johannes, 2013. "Leveraging private capital for climate mitigation: Evidence from the Clean Development Mechanism," Ecological Economics, Elsevier, vol. 96(C), pages 14-24.

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