Can Extensive Grassland Management Pay Off for Farmers Facing Drought Risks? A Cumulative Prospect Theory‐Based Approach

ABSTRACT Grasslands in Central Europe are increasingly affected by droughts, leading to lower hay yields and reduced profits for dairy farmers. The insurance hypothesis suggests that extensively managed, species‐rich grassland is more drought resistant than intensively managed grassland. However, it produces lower yields in non‐drought years, creating a trade‐off between maximising yield and improving stability. In this study, we analyse how this trade‐off translates into farmers' management decisions. Using a mechanistic bio‐economic model, we evaluate outcomes across a wide range of simulated ecological, climatic and economic input conditions. We apply classification tree analysis to identify key drivers of extensive management under expected utility, cumulative prospect theory and an extension we call reference‐based valuation, where outcomes are valued relative to management‐specific expectations. Results suggest that farmers who evaluate profits against the expected outcome under each management intensity potentially adopt extensive management despite lower expected profit if it offers greater stability during droughts. By contrast, when outcomes are compared to the status quo of intensive management, or when farmers maximise utility, extensive management is only predicted if foregone yields do not outweigh higher drought stability. Our findings highlight that adoption decisions depend strongly on the valuation perspective, motivating further applications of reference‐based behavioural models and research on how farmers' reference profits might evolve under climate change. They also suggest policy entry points: targeted extension services and demonstration farms could broaden evaluation perspectives, while financial incentives such as payments for ecosystem services could reduce adoption thresholds due to forgone yields under profit‐oriented decision‐making.