1 Optimal afforestation contracts with asymmetric information on private benefits Ph.D. Student Signe Anthon

2 Outline Introduction The Danish afforestation scheme The landowner Principal-agent model Results Perspectives

3 Introduction Subsidy schemes for procurement of new forest land Analysis of mechanism design in a principal- agent context Agents with private benefits from afforestation With private information → adverse selection

4 The Danish afforestation scheme Doubling of the Danish forest area in years Afforestation on marginal agricultural land Policy goals Enhance wood production Improve recreational possibilities Improve biodiversity Protection of the environment (e.g. ground water)

5 The Danish afforestation scheme Initiated in 1992 More then ha plantet on private land Flat rate payments for activities up to 7500 €/ha Selection criteria Geography Environmental protection Size

6 The landowners Empirical study on private landowners (Jensen 1999) Primary motives for afforestation 38% want to improve wildlife on their land 48 % stated termination of agricultural production 13 % stated economic considerations 76 % part time farmers

7 The landowners Profit function Where C e = cost of establishment (and all future income). C e is inscreasing in project quality x and C e ’>0 C oc = opportunity costs s = subsidy u = monetary equivalent of private utility, increasing in x. u’(x) > 0 and u’’(x) < 0 k = constant

8 The landowners The implication of positive private utility from afforestation

9 The landowners Two types of agents ’Conventional’ landowner: Normal private utility from any afforestation project: k=1 ’Green’ landowner Higher private utility from any afforestation project: k > 1

10 The landowners x s Green Conventional

11 Principal-agent model The contracts Two contracts: {x G, s G } and {x C, s C } Participation constraint Incentive constraint:

12 Principal-agent model Welfare function Welfare function of private afforestation project i U = the positive utility derived from the project with quality x V = society’s disutility of spending s on the project We assume U’(x) > 0 and U’’(x) < 0 V’(s) > 0 and V’’(s) >0

13 Principal-agent model Maximises the welfare gain on the condition of the participation of both landowner types

14 Results The green contract Pareto-optimal but overcompensated

15 Results The conventional contract Not pareto-optimal but no overcompensation

16 Results Trade-off When designing subsidy schemes the principal has a tradeoff between 1) Overcompensating the green landowner 2) Using too little on the conventional contracts Green landowners are main suppliers → poor contracts for conventional landowners Conventional landowners are main suppliers → small differences between projects and larger overcompensations

17 Results Large difference between types (k): Larger k → Larger overcompensation of the green landowner AND poorer contracts for the conventional landowners

18 Perspectives and future work Private utility from afforestation If private utility exists, the subsidy should be lower or/and the quality of the projects higher The problem is estimation of private utility and k