OF INVESTMENT AND BOUNDED RATIONALITY
In reality, TOs cannot impose green management, but they can set incentives for hotels to change their management practices. Specifically, by sharing the price premium for environmental quality with hotels, a TO can steer hotels to adopt green practices to a desired level. How this strategy is implemented and its results will depend on our behavioural assumptions regarding the implied economic agents. Thus, in many destinations, the accommodation supply is dominated by MSEs (Jones & Haven-Tang, 2005) that are far from being perfectly informed fully rational agents. Considering this situation, we assume that hotels in the model are bounded rational. Thus, hotels have a limited ability to process all the information that they need to make rational choices, and, as a consequence, they use rules of thumb and shortcuts to make decisions (Simon, 1957).
The case of TOs is different because they typically constitute large companies with precise information about both tourism demand and supply. Therefore, we retain the assumptions of full information and rationality for TOs. As is shown below, this new approach leads us to reinterpret the problem as an investment decision by the TO79. Specifically, we modify our assumptions along the following lines:
78 If , then a corner solution is reached where = .
79 Another possible extension might be to maintain the primary assumptions on rationality and information and develop a game-theoretical bargaining model. This step would imply that the Rubinstein bargaining model (Rubinstein, 1982) should be applied to our setting. This application is not straightforward because Rubinstein’s model applies to a two-player game. Some extensions of the Rubinstein bargaining model have been made for multi-player settings (see Huang, 2002), but they cannot be directly applied to the TO–hotels type of relationship that we consider in this paper.
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The first sense in which hotels are considered to be bounded rational considers that, because of information costs, hotels are not able to either calculate the marginal effect of their individual decisions on the environmental quality of the destination or determine the effect on revenues of an environmental quality improvement.
A corollary of this interpretation stipulates that an incentive scheme based on sharing the environmental quality price premium with all (green and non-green) hotels cannot affect the behaviour of the hotels in the market in any way because they are not aware of their own capacity to increase the price premium by becoming green. In that case, hotels take the price premium as given and are thus indifferent between green or conventional management.
Thus, a different incentive scheme that establishes a difference between the payoffs of green and non-green hotels is required to affect the behaviour of bonded rational hotels. This scheme is achieved when only green hotels receive a payment from the TO. This payment, which we call h, is received each period provided that the hotel undertakes green management. This payment can be interpreted as the share of the environmental quality price premium that is received by green hotels.
Given this payment, a hotel is willing to become green if and only if the payoff from this strategy is at least as large as the payoff from continuing with non-green management.
A second implication of the bounded rationality of hotels is the organisational inertia that (we assume) impedes green management adoption. This inertia may come from uncertainty about the consequences of adopting green management. Uncertain costs associated with green management may come, for instance, from workers’ resistance to changing work habits. Revenues from green management may also be deemed to be uncertain by the hotel manager if they are conditioned on realising the resulting environmental price premium, which the hotel cannot adequately foresee, as discussed above. Therefore, because a hotel’s decision to shift to green management is not governed by a fully informed calculation of pros and cons, we opt to model the entire
185 population of hotels using linear replicator dynamics as follows instead of modelling the individual behaviour of hotels. Under this assumption, during each period, only a fraction of the hotels that undertake the lowest payoff strategy change to the highest payoff strategy80.
A third and final implication of the hotels’ bounded rationality is that we assume that they do not act strategically and are myopic in the sense that they only care about the immediate consequences of their decision regarding green management. However, the TO is assumed to be forward-looking. We also assume that the TO is willing to bear all the costs necessary for hotels to become green, which can be justified by the existence of agency problems. If hotels take charge of the greening process, they have private information as to what extent and with what effectiveness they have greened their management. Therefore, they may have incentives to cheat the TO, which might allow them to avoid the cost of changing their management and still receive the payment from the TO. To prevent this behaviour, we assume that the TO assumes direct control of the greening process of those hotels that decide to become green.
Finally, for purposes of public policy analysis, we assume that the government in the tourism destination is willing to promote green management by hotels. With this objective, the government provides a subsidy (g) to those hotels that undertake green management81.
Given these assumptions, hotels’ behaviour regarding green management is determined by the following expression:
(1)
80 In the literature, a slow adjustment to profit-maximizing behaviour is commonly assumed in different settings such as evolutionary economics models (Blanco et al., 2009), natural resource management (Rondeau & Bulte, 2007) or microeconomic models of production (Howroyd & Rickard, 1981; Szidarovsky & Yen, 1995).
81 An incentive for the local government not to leave the promotion of green management entirely in the hands of the TO is that the environmental quality may have sources of value that are not taken into account in the tourism market. These sources include the valuation of environmental quality by residents.
186 where Sg=Ng/N is the fraction of green hotels and a dot indicates the rate of change over time.
The term h+g is the profit differential between green and non-green hotels and ) is a parameter that indicates how fast the population of hotels responds to profit differentials.
The TO is represented as a forward-looking profit-maximizing agent whose profits per unit of time are the following:
(2)
where the first term represents revenues attributable to the environmental quality of the destination. For convenience and without loss of comparability to the previous section, we have assumed that the TOs’ revenues depend on the share of green firms instead of the number of green firms, that is,
(3)
The second term in expression (2) represents the payments made by the TO to hotels to induce them to adopt green management. As discussed above, these payments are made only to those hotels that are green. The third term is the cost of greening hotels’ management practices. These costs are incurred only during those periods when a hotel changes its management practices82. Thus, it depends on the rate of change of Sg. For a given period, if only one hotel becomes green, the incurred cost is , as in the previous section83. However, the marginal costs for the TO are assumed to increase with the number of hotels that become green contemporaneously.
82 The inclusion of period by period operational costs associated with green management would add little to our results.
83 It can be easily shown that, for a constant N, , and the cost of greening is thus when .
187 The TO’s decision consists of choosing a stream of values for h to maximize the discounted value of the sum of the TO’s profits through its time horizon, which is assumed to be infinite, expressed as the following:
(4)
where r is the market interest rate. As such, the problem is framed as an investment decision by the TO. In essence, the TO is investing in natural capital (environmental quality) through the indirect mechanism of inducing hotels to adopt green management. Thus, the decision variable h can be interpreted as an investment rate, the state variable, Sg, can be interpreted as the stock of capital and, therefore, can be interpreted as an investment rate. Through this lens, the last term in expression (2) represents investment costs, for which a quadratic form is assumed. The quadratic form of investment costs has been used in many previous studies (Szidarovsky & Yen, 1995; Wang & Wen, 2012; De Santis et al., 2004; Candela & Cellini, 2006) and links our model to the standard Tobin’s Q investment model.