TRANSACTION CHAIN APPROACH TO THE REGULATION OF THE NONPOINT WATER POLLUTION FROM FARMS-RUNOFF

We offer a decentralized solution to the asymmetric information and hidden action problems in the nonpoint source (NPS) pollution case. Farmers in the same watershed generate homogeneous NPS pollution. The regulator, R, pays for (or represents a group of point-source, PS, polluters who pay for) pollution reduction credits earned by the group of the farmers. To resolve the asymmetric information problem, R is concerned with only the total level of the abatement achieved, while the group of farmers (called the Association, A), undertakes responsibility to distribute the payment so as to induce farmers to deliver abatement. We show that A can devise an optimal contract to deal with the farmers' hidden action problem. We identify the restrictions under which such a policy can be implemented, evaluate its effects on the product market, and show that in the NPS case information rents are higher than in the PS case.