In general, the use of incentive payments to landholders in environmental programs is poorly thought through. This article discusses situations where environmental incentive payments are more likely to be a cost-effective response by environmental funders. It is proposed that incentives can be used in two broad ways: to encourage trialling of new practices by landholders, or to compensate landholders for losses resulting from land-use changes. It appears that environmental funders often do not pay sufficient attention to the differences between these two approaches. The first approach only makes sense if the new practices are 'adoptable', and so are expected to remain attractive to landholders beyond the trialling phase. The importance of adoptability and the factors likely to influence the adoptability of an innovation are discussed. The question of who should pay is relevant to whether incentives are appropriate, but is largely political, rather than economic. The concept of market failure is of little practical relevance to environmental funders wishing to target and prioritise their investments. A set of key questions is proposed for environmental funders to address when considering the potential role of incentives.