Adverse Selection in Conservation Auctions: Theoretical and Experimental Results

This paper evaluates land preservation and conservation programs by examining the performance of a discriminative auction that is often used to select parcels in the U.S. The paper hypothesizes that the auction is unlikely to be cost effective because an information asymmetry introduces adverse selection. Experiments are used to examine the extent of adverse selection and compare it to a baseline where no programs exist. Then, we examine the ability of two mechanisms to correct the incentive problem. The results show that adverse selection is likely to exist in conservation auctions (achieving just 60.7% of total possible social efficiency in the experiments) and that a mechanism can sort types so as to improve cost effectiveness with respect to the specific information asymmetry (90-92% of total social surplus). However, the mechanisms involve large transfers and the experiments show that a simple externality-correcting tax can achieve more cost effectiveness (99.4% of social efficiency) with lower transfers. This is an important result for policy because recent trends are focused on expanding fiscally costly auctions rather than taxes. The result also is surprising and important for researchers because there is little intuition as to why the tax resolves the selection problem.