Academic journal article Agricultural and Resource Economics Review

The Effective Use of Limited Information: Do Bid Maximums Reduce Procurement Cost in Asymmetric Auctions?

Academic journal article Agricultural and Resource Economics Review

The Effective Use of Limited Information: Do Bid Maximums Reduce Procurement Cost in Asymmetric Auctions?

Article excerpt

Conservation programs faced with limited budgets often use a competitive enrollment mechanism. Goals of enrollment might include minimizing program expenditures, encouraging broad participation, and inducing adoption of enhanced environmental practices. We use experimental methods to evaluate an auction mechanism that incorporates bid maximums and quality adjustments. We examine this mechanism's performance characteristics when opportunity costs are heterogeneous across potential participants, and when costs are only approximately known by the purchaser. We find that overly stringent maximums can increase overall expenditures, and that when quality of offers is important, substantial increases in offer maximums can yield a better quality-adjusted result.

Key Words: conservation auctions, Conservation Reserve Program, CRP, bid caps, experimental economics

(ProQuest: ... denotes formulae omitted.)

Many environmental goods and services are generated from natural resources that are privately controlled. Thus, programs to enhance their provision require the participation of non-government actors. In many cases, these programs do not use regulatory approaches. Instead, the government pays owners of the resources to voluntarily change their practices.

Assuming that the government prefers to minimize expenditure, or to maximize social welfare, program implementation needs to consider the design of an enrollment mechanism. The enrollment mechanism can consider a number of goals. These include:

* minimizing payment, with a target of paying the reservation price to participants;

* encouraging broad participation, so as to attract low-cost providers to the program;

* encouraging program participants to improve environmental quality whenever it is cost-effective.

Achieving this suite of goals may not be easy. The inherent difficulty arises because of an asymmetry of information-the government has superior information about how particular land-use decisions translate to environmental quality, while private landowners have superior information on the private cost of undertaking specific practices (Cason and Gangadharan 2004).

Motivation: The Case of the CRP

As an important example, consider the USDA's Conservation Reserve Program (CRP), which achieves its habitat and soil protection goals by paying landowners to retire their land from active crop production. The CRP's enrollment mechanism is competitive, with interested landowners placing offers for acceptance into the program during scheduled sign-ups. There are three major components of the enrollment mechanism:1,2

* Each parcel offered is scored using an Environmental Benefits Index (EBI). The EBI is a linear combination of several measures of the environmental benefits achieved by retiring the offered land, and the size of the payment demanded by the landowner (the bid). Only offers that achieve a target EBI are accepted.

* Landowners can increase their EBI score by adopting beneficial conservation practices. However, landowners must incur some out-ofpocket costs to install these practices, thereby reducing their net revenues.

* Landowner bids are capped, with the cap based on a soil rental rate derived from adjusting a county average agricultural land rental rate with a measure of the soil productivity of the offered land.

In total, the CRP uses a sealed-bid reverse auction with (i) a maximum bid established by a quick-and-dirty land-rent assessment, and (ii) a quality-adjusted scoring method. That is, there are two mechanisms to limit the economic rent a landowner might achieve by participating in the auction: the soil rental rate (the assessment) and the EBI ranking (the quality-adjusted score).

A critical component determining the total cost of operating the CRP is the asymmetric distribution of landowner opportunity costs. Some landowners have low opportunity costs (e. …

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