Adverse Selection in the Environmental Stewardship Scheme: Does the Higher Level Stewardship Scheme Design Reduce Adverse Selection?

The Environmental Stewardship Scheme provides payments to farmers for the provision of environmental services based on foregone agricultural income. This creates a potential incentive compatibility problem which, combined with information asymmetry about farm land potential, can lead to adverse selection of land into the Scheme and therefore a less cost‐effective provision of environmental goods and services. However, the Higher Level Stewardship (HLS) Scheme design includes some features that potentially reduce adverse selection. This paper studies the adverse selection problem of the HLS using a principal‐agent framework at the regional level. It is found that, at the regional level, the enrolment of more land from lower payment regions for a given budget constraint has reduced the adverse selection problem through contracting a greater overall area and thus higher overall environmental benefit. In addition, for landscape regions with the same payment rate (i.e. of the same agricultural value), differential weighting of the public demand for environmental goods and services provided by agriculture (measured by weighting an environmental benefit function by the distance to main cities) appears to be reflected in the regulator’s allocation of contracts, thereby also reducing the adverse selection problem.