Use of Penalties and Rewards in Agri-Environmental Policy

Achieving high compliance rates in incentive-based agri-environmental schemes is an important issue. This paper explores the use of a mixed penalty-reward approach under heterogeneous compliance costs. Specifically, we examine the use of a “compliance reward” under asymmetric information and output price uncertainty. Using a budget-neutral approach, three possible sources of financing are considered: 1. funds obtained by reducing monitoring effort; 2. the proceeds of fines collected from participating farmers who are inspected and found not to be in compliance; and 3. money saved by reducing the number of farmers enrolled. We discuss the advantages and disadvantages of each source of funding and analyze them numerically for both risk-neutral and risk-averse farmers. We show that under certain conditions a mixed penalty-reward system can increase the likelihood of compliance without increasing programme costs. For risk-averse farmers, however, conditions that ensure a positive outcome from compliance rewards become more restrictive. The implications of these findings are outlined for the future design of agri-environmental schemes with reference to cost-share working lands programmes such as EQIP in the United States