Use of Penalties and Rewards in Agri-Environmental Policy

Achieving high compliance rates in incentive-based agri-environmental schemes is animportant issue. This paper explores the use of a mixed penalty-reward approach underheterogeneous compliance costs. Specifically, we examine the use of a “compliancereward” under asymmetric information and output price uncertainty. Using abudget-neutral approach, three possible sources of financing are considered: 1. fundsobtained by reducing monitoring effort; 2. the proceeds of fines collected fromparticipating 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 advantagesand disadvantages of each source of funding and analyze them numerically for bothrisk-neutral and risk-averse farmers. We show that under certain conditions a mixedpenalty-reward system can increase the likelihood of compliance without increasingprogramme costs. For risk-averse farmers, however, conditions that ensure a positiveoutcome from compliance rewards become more restrictive. The implications of thesefindings are outlined for the future design of agri-environmental schemes withreference to cost-share working lands programmes such as EQIP in the United States.