Regulating Nitrogen Pollution with Risk Averse Farmers Under Hidden Information and Moral Hazards

Abstract

We consider a model of pollution regulation for a risk averse farmer involving hidden information, moral hazard, and risk-sharing. The representative farmer faces a production risk originating from nitrogen leaching, and privately observes the soil capacity in retaining nitrogen only after the regulation contract is signed. The latter specifies a transfer and a nitrogen quota, whose decomposition by the farmer among different production stages is unknown to the regulator. We first characterize the optimal solution to the regulator`s problem. The sequential decision model is estimated on French crop production data, and the results are used to calibrate and simulate the optimal contract.