The Law and Economics of Environmental Contracts

53 Pages Posted: 9 May 2000

See all articles by Jason Scott Johnston

Jason Scott Johnston

University of Virginia School of Law; PERC - Property and Environment Research Center

Date Written: September 1999

Abstract

This paper develops a simple economic framework that is used to explain and critique the recent trend favoring site-specific contractual commitments in environmental regulation. Such contracts typically involve an exchange under which the regulator relaxes ostensibly inflexible uniform environmental regulations and allows development to proceed upon the condition that the developer complies with the negotiated, site specific requirements. The developer gets a formal, explicit promise from regulators that they will not impose any further requirements for some fixed period. The paper surveys some important recent instances of such agreements ? habitat conservation plans under the Endangered Species Act, Brownfields redevelopment agreements, EPA?s Project XL, and in-lieu-fee wetlands mitigation. It then argues that these agreements make three shifts in environmental regulatory policy: 1) a substantive shift to focus on outcomes ? such as ecosystem value and risk reduction ? as opposed to inputs; 2) a process shift under which the role of national interest groups is reduced; and 3) the use of potential legal liability as a way of committing regulators not to renegotiate in the future. The (informal) model of the paper views regulatory contracts as negotiated in the shadow of the credible default regulatory outcome, which it takes as itself the product of bargaining. This model immediately implies that if the contractual bargaining environment does not differ from the default regulatory bargaining environment then environmental contracts will simply replicate default regulatory outcomes. Borrowing from the economic theory of private contracts suggests that key determinants of the social desirability of regulatory contracts will include: 1) the relative information available to the parties at the time the contract is negotiate, and, 2) the identify of the parties to the contract ? whether they are sufficiently representative to lower the likelihood of inefficient externalization under the contract. Moreover, unlike private contracts, a party to the contract ? the regulator (generically) ? also determines the present default regulatory outcome, but is likely not the agent in control of future regulation.

The paper first applies this framework to explain why environmental contracts arose during the mid-90?s: at a time when the 104th Congress brought a credible threat to undo stringent uniform regulations, making site-specificity a way for environmental regulators to get around national interest groups and get more than they could otherwise have obtained. More generally, the paper argues that the fundamental shift marked by environmental contracts has been to lessen the role played by national interest groups (relative to the default regulatory regime), thereby allowing local development and resource use (as opposed to existence) values, and firm and site-specific efficiencies to be reflected in environmental contracts in a way that they are not under the default regulatory regime. [The paper also explains briefly why national interest groups are at an economic disadvantage in attempting to influence multiple localized environmental contracts relative to uniform national regulations]. On the other hand, if national interest groups are completely excluded from the negotiation of localized agreements, then such agreements risk externalization and inefficiency due to information asymmetry. To get the benefit of information and representation by national groups without destroying the incentive of firms to disclose private information during negotiations, the paper recommends that national groups be allowed to participate in such negotiations but only on condition that they waive the right to challenge the agreement later.

The final part of the paper explores the desirability of replacing political commitments not to renegotiate with legally binding commitments. The general regulatory commitment problem is that firms will not agree to mitigate environmental harms today without a commitment that the regulator will not demand even more tomorrow. Were courts to hold that environmental contracts are legally binding, the potential damage liability under such contracts might allow governments to commit. However, this rests on implicit assumptions regarding the legislature?s willingness to actually fund governmental liability. The paper shows (relying on related work by the author and co-authors) that the imposition of potential governmental liability is likely to feedback and alter the types of commitments that the regulator is likely to make in the first place.

JEL Classification: Q28, Q38, k32

Suggested Citation

Johnston, Jason Scott, The Law and Economics of Environmental Contracts (September 1999). Available at SSRN: https://ssrn.com/abstract=208688 or http://dx.doi.org/10.2139/ssrn.208688

Jason Scott Johnston (Contact Author)

University of Virginia School of Law ( email )

580 Massie Road
Charlottesville, VA 22903
United States

PERC - Property and Environment Research Center

2048 Analysis Drive
Suite A
Bozeman, MT 59718
United States

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