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Enforcement-proof contracts with moral hazard in precaution: ensuring ‘permanence’ in carbon sequestration

MacKenzie, Ian A., Ohndorf, Markus and Palmer, Charles (2010) Enforcement-proof contracts with moral hazard in precaution: ensuring ‘permanence’ in carbon sequestration. Centre for Climate Change Economics and Policy and Grantham Research Institute on Climate Change and the Environment, 27. Centre for Climate Change Economics and Policy and Grantham Research Institute on Climate Change and the Environment, London, UK.

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Abstract

Opportunistic behaviour due to incomplete contract enforcement is a risk in many economic transactions such as forest carbon sequestration contracts. In this paper, an enforcement-proof incentive contract is developed in which a buyer demands a guaranteed delivery of a good or service given a productive upfront payment, moral hazard in precaution, and the potential for opportunistic contract breach. The optimal design of forest carbon contracts to ensure permanence is derived. Buyer liability for loss of a carbon sink is shown to yield an inefficiently low level of sequestration. Yet it remains higher than the case where liability is neither allocated to the buyer nor the seller. Indexing contract prices to the seller’s opportunity costs potentially boosts the upfront investment as does shifting liability to the seller but not beyond first-best levels. Assigning liability is shown to have implications for forest carbon contracts in an international climate policy regime.

Item Type: Monograph (Working Paper)
Official URL: http://www2.lse.ac.uk/GranthamInstitute/Home.aspx
Additional Information: © 2010 The Authors
Library of Congress subject classification: G Geography. Anthropology. Recreation > GE Environmental Sciences
H Social Sciences > HC Economic History and Conditions
Journal of Economic Literature Classification System: K - Law and Economics > K1 - Basic Areas of Law > K12 - Contract Law
Q - Agricultural and Natural Resource Economics; Environmental and Ecological Economics > Q1 - Agriculture > Q15 - Land Ownership and Tenure; Land Reform; Land Use; Irrigation
Sets: Departments > Geography and Environment
Research centres and groups > Grantham Research Institute on Climate Change and the Environment
Collections > Economists Online
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Identification Number: 27
Date Deposited: 16 Dec 2010 10:36
URL: http://eprints.lse.ac.uk/30846/

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