A theoretical model with nonlinear discarding costs is constructed to describe highgrading in a fishery with an Individual Transferable Quota (ITQ) program. The model shows that ITQs provide incentives to discard fish when the hold capacity of the vessel is nonbinding. An empirical model is developed to test for highgrading and to predict the discarded quantities of different grades of fish. This model is applied to the Icelandic ITQ-regulated cod fishery. Net and long-line vessels are involved in highgrading and the quota price induces highgrading for net vessels. The predicted total discarded quantities are 4.7% and 2.7% of total landings for net and long-line vessels, respectively. Long-line and net vessels are predicted to discard 18% and 76% of their small cod catch, suggesting that resource managers should focus on net vessels. These discard rates correspond well with biometric estimates, suggesting that economic modeling is a useful alternative method.