COMMUNICATION AND INCENTIVE MECHANISMS BASED ON GROUP PERFORMANCE: AN EXPERIMENTAL STUDY OF NONPOINT POLLUTION CONTROL

I. INTRODUCTION The problem of moral hazard in groups, wherein the hidden actions of individuals create an inherent divergence between individually and collectively optimal behaviors, has engendered an expanding theoretical literature on group performance incentive mechanisms to induce desirable levels of collective action. Examples include provision point and incentive-compatible public goods funding mechanisms in public economics (e.g., Bagnoli and McKee 1991; Grovesand Ledyard 1977; Smith 1980); team performance mechanisms, such as revenue sharing schemes, forcing contracts and competitive tournaments in the contract theory literature (e.g., Holmstrom 1982; Nalbantian and Schotter 1997); and ambient-based pollution control instruments in environmental economics (e.g., Segerson 1988). The theoretical development of group performance mechanisms has for the most part been predicated on the assumption that group members do not explicitly coordinate their efforts. (1) Yet group performance mechanisms are often best suited for or are actually implemented in situations in which communication and perhaps cooperation seem likely (Che and Yoo 2001; Segerson 1999). Thus, from the perspectives of both theory and policy, it is critical that the influence of communication on the effectiveness of these group performance mechanisms be empirically investigated to determine whether there are instances where encouraging coordination can be beneficial (or not) in realizing a particular collective outcome. The focus of this article is on testing experimentally the effect that nonbinding communication, or so-called cheap talk, has on group performance mechanisms. (2) Drawing from the theoretical literature, it has been argued that cheap talk can serve to rule out certain equilibria as being implausible (Baliga and Morris 2002; Farrell 1988), expand the set of equilibria (Farrell and Gibbins 1989), and help avoid misunderstandings and coordination failures that lead to inefficient outcomes (Farrell and Rabin 1996; Aumann and Hart 2003). Evidence from laboratory experiments suggests that cheap talk can aid in disseminating information on strategies that are optimal for the group, serve to increase trust among group members and thus alter expectations of other agents' behavior, and add additional values to the subjective payoff structure (Ostrom 1998). By itself, however, the introduction of communication is not sufficient to ensure efficient outcomes, and in some instances cheap talk may have no influence whatsoever (Croson and Marks 2001). Though the effect of communication in the context of voluntary public goods funding mechanisms has been well documented (see Davis and Holt 1993), there is little empirical evidence on the role of communication in the context of mechanisms intended to induce theoretically optimal individual actions. One context in which group performance and communication can be particularly important is the regulation of nonpoint source pollution. In this context, the group moral hazards problem is cogent, arising from the fact that emissions are diffuse and individual firm emissions cannot be observed with sufficient accuracy at a reasonable cost. In particular, it is difficult to infer emissions from firm inputs or land management practices because of complex fate and transport mechanisms, stochastic environmental factors, and a multiplicity of pollution sources. As a solution to the group moral hazards problem inherent in nonpoint source pollution, economists, starting with Segerson (1988), have focused on designing policy instruments that regulate a group of polluters based on ambient pollution levels (Cabe and Herriges 1992; Hansen 1998, 2002; Herriges et al. 1994; Horan et al. 1998, 2002). Under Segerson's (1988) general incentive scheme, each polluter pays penalties (receives subsidies) if ambient pollution at a common monitoring point--the group performance measure--exceeds (falls below) a pollution target. …