Too Burdensome to Bid: Transaction Costs and Pay-for-Performance Conservation

In a world free of transaction costs, reverse auctions have the potential to cost-effectively allocate payment for environmental service contracts by targeting projects that provide the most benefit per dollar spent. However, auctions only succeed if enough farmers choose to bid so that the auctioneer can evaluate numerous projects for targeted funding. A 2014 conservation auction to allocate payments for practices that reduce phosphorus runoff in Northwest Ohio experienced very thin bidding. According to a follow-up survey, auction participation was deterred by the perceived complexity of the bidding process and the need to negotiate with renters. Due to low participation, the actual conservation auction made payments for phosphorus reduction that were surprisingly costly at the margin. Applying a farmer behavioral model to the Western Lake Erie Basin, we simulate participation choice and cost-effectiveness of environmental outcomes in reverse auctions and uniform payment conservation programs. Results reveal that when perceived transaction costs of bid preparation are high, reverse auctions can be less cost-effective than spatially targeted, uniform payment programs that attract higher participation.