Auctioning Risky Conservation Contracts
Conservation auctions have the potential to increase the efficiency of payments to farmers to adopt conservation-friendly management practices by fostering competition among them. The literature considers bidders that have complete information about the costs of adoption and optimal bidding behavior reflects this information advantage. Farmers seek information rents and bids decrease when risk aversion increases because farmers are more averse to losing the auction. We contribute to the literature by allowing for cost risk. Our paper shows that farmers must balance the risk of losing the auction (thus foregoing information rent) with the risk of submitting a bid that is not high enough to pay the costs of adopting conservation practices (thus incurring losses). We design an experiment to trade off these two risks and examine how risk aversion affects bidding behavior when participants face different sources and levels of risk. Our experiment contributes to a small literature on experimental auctions with risky product valuations. We find that participants decrease their bids as risk aversion increases, even in auctions with cost risk, suggesting that the risk of losing the auction dominates. These findings uncover new challenges for the practical implementation of conservation auctions as an efficient policy instrument.
KeywordsBeneficial management practices Cost risk Environmental goods and services Experiments Reverse auctions Risk aversion
We would like to thank Philippe Marcoul and Jens Schubert for helpful comments. Financial support for this research was provided by the Watershed Evaluation of Beneficial Management Practices (WEBs) project of Agriculture and Agri-Food Canada (AAFC 1585-10-3-2-1-3) and from the Australian Research Council’s Discovery Fund, Project ID 150104219. The authors are solely responsible for any omissions or deficiencies.
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