Limits to Environmental Bonds: Lessons from the Labor Literature

Jason F. Shogren, Joseph A. Herriges, Ramu Govindasamy
November 1991  [91-WP 82]

Bonds have recently been promoted as an alternative tool for controlling environmental damages, particularly in those instances when the innovative activities of a firm have uncertain future impacts [Costanza and Perrings (1990)]. Under this mechanism, a firm would post a bond ex ante, forfeiting the bond if its activities caused harm to environmental resources. While the benefits of bonds have been developed, there has been little systematic effort to explore their limitations. The labor literature, on the other hand, has extensively studied the limits of bonds as a mechanism for preventing worker shirking. Using the insights found for this parallel problem, this paper explores the limits to environmental bonds, focusing on the problems of moral hazard, liquidity constraints, and legal restrictions. Each limit offers a challenge to the success of environmental bonds. We explore the use of bonds to resolve agricultural nonpoint source pollution problems as a motivating example. We also consider how other incentive schemes suggested by the labor literature might prove useful in the context of environmental management. Specifically, we consider the labor mechanisms of efficiency wages, increasing wage profiles, trust funds, and rank-order tournaments.

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