CDM projects have large potentials but also face significant obstacles that have so far limited their applicability. Two serious problems that an effective contracting faces are the presence of private information and the lack of sufficiently precise output measures. In a principal–agent framework, where local landowners are the agents and have private information about their costs, we analyse the implication of being able to condition payments to the agent based on observed output and therefore can offer a differentiated contract. This is compared with a situation where only a uniform payment structure is feasible. In the case of reforestation projects, and with respect to both economic and sustainability criteria, our model point to that a differentiated payment structure based on output due to remote sensing is superior to a uniform contract.
Keywords: clean development mechanism, CDM projects, REDD, Reducing Emissions from Deforestation and Forest Degradation programme, greenhouse gases, GHG emissions, reforestation, sustainability, principal agent, private information, sustainable development, output measures, differentiated contracts, uniform payment, remote sensing