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

Ian MacKenzie (), Markus Ohndorf () and Charles Palmer ()

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

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.

Keywords: forest carbon offsets; permanence; contract design; incomplete enforcement; liability; moral hazard (search for similar items in EconPapers)
JEL-codes: K12 Q15 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2010-09
References: View references in EconPapers View complete reference list from CitEc
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http://eprints.lse.ac.uk/30846/ Open access version. (application/pdf)

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Journal Article: Enforcement-proof contracts with moral hazard in precaution: ensuring 'permanence' in carbon sequestration (2012) Downloads
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