Using Principal-Agent Theory to Deal with Output Slippage in the European Union Set-Aside Policy

This paper proposes modifications to the existing EU set-aside policy which are designed to alleviate the problem of output slippage associated with heterogeneous land quality by using "incentive-compatible" mechanisms drawn from principal-agent theory. Specifically, it is suggested that there should be differential reference yields based on land quality to discourage the "adverse selection" of lower quality land for set-aside, and that the scope of set-aside monitoring should be expanded to include both the quantity and the quality of land set-aside so as to discourage "moral hazard" problems. The potential of these modifications is illustrated using a numerical analysis, which is also used to evaluate the role of a range of factors which determine the set-aside decision. Finally, an estimate of the "benefits" from reducing slippage required to justify the costs of including these modifications is provided.