Incentivizing Efficient Effort When Monitoring Individuals Is Costly

Abstract

We propose and explore, both in theory and the laboratory, a mechanism to incentivize optimal individual abatement effort in groups of polluters when individual-level monitoring is costly. The mechanism we propose is a hybrid; rewarding agents for the achievement of a group-level target, while allowing individuals to protect themselves against coordination failure by electing to purchase individual-level monitoring. By exerting optimal individual effort, a monitored agent can guarantee their reward irrespective of group behavior. We show that the unique Nash equilibrium is characterized by group members exerting optimal levels of individual effort while not purchasing monitoring. Thus, the hybrid mechanism disincentivizes free riding without realizing monitoring costs. Laboratory experiments confirm that the hybrid mechanism offers welfare gains compared to stand-alone lump-sum group-level incentives and instruments mandating individual-level monitoring. Moreover, the hybrid mechanism maintains levels of efficiency comparable to a group tax but with more desirable out-of-equilibrium properties.