1. There is growing interest in the potential of payments for ecosystem services (PES) to encourage land managers to protect and enhance the environment. However, questions remain about how PES agreements should be designed. There is a division between schemes that structure payments by action or by results, with most biodiversity PES schemes, including European agri-environment schemes, paying by action; for example incentivising land managers to carry out actions believed to increase biodiversity. Payment by results is a common incentive structure in the private sector (e.g. labourers doing piece work or no-win no-fee lawyers) but rarer in PES.
2. Using a theoretical modelling approach, we investigate the conditions under which each way of structuring payments may be more cost-effective in a biodiversity PES.
3. Payment by action is favoured where there is a clear action that can be specified at an appropriate level and to which biodiversity is sensitive. We found that payment by results is favoured in degraded landscapes as incentives are created for managers to use their private knowledge and join the scheme only if they can produce the biodiversity services targeted by the scheme. Payment by results is also favoured where biodiversity is less sensitive to conservation action and when it is difficult for a central agency to determine an appropriate level of conservation action. This is because payment by results allows individual managers to optimise their level of action.
4. The relative cost of monitoring action (compliance with an agreement to manage in a certain way) versus results (the presence of biodiversity) has a substantial effect on which payment structure is more efficient only when the central agency can accurately set an appropriate level of action. We illustrate these principles with examples based on agri-environment schemes.
5. Synthesis and applications. Payment by results deserves more attention from those designing biodiversity PES (be they agri-environment schemes in agricultural landscapes or direct payment schemes in more intact ecosystems). This paper provides a formal framework to help policy makers identify the conditions under which payment by results or payment by action is most likely to yield cost-effective biodiversity conservation.