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

Ian MacKenzie, Markus Ohndorf and Charles Palmer

Oxford Economic Papers, 2012, vol. 64, issue 2, 350-374

Abstract: Opportunistic behaviour due to imperfect contract enforcement is a risk in many economic transactions. 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. Investing in a contract upfront is found to be restricted by moral hazard and opportunistic contract breach. This limits the size of investment up to a specific level even if an infinite scale-up of production were beneficial. A more severe moral hazard problem results in a smaller distortion. The framework is applied and extended to international carbon sequestration contracts. In comparison to alternative liability attributions, the current regime of buyer liability yields inefficiently low levels of investment in carbon sequestration. Copyright 2012 Oxford University Press 2011 All rights reserved, Oxford University Press.

Date: 2012
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Working Paper: Enforcement-proof contracts with moral hazard in precaution: ensuring ‘permanence’ in carbon sequestration (2010)
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