Contracts

Cooperatives help members manage marketing risk within a season, but not production risk across years. We show how the multi-year cooperative relationship can also provide limited crop insurance. Download Paper Abstract Agricultural cooperatives have long played an important role in helping their members manage risk, though they do a much better job of helping members manage some sorts of risk than others. In particular, co-ops are good at helping members manage marketing risk, but seem not to be particularly good at helping their members manage production risk. This paper argues that by taking advantage of the multi-year nature of most members’ relationship with the cooperative, the cooperative can also provide a useful, though limited, form of insurance against crop shortfalls. ...

Contracting is pervasive in agriculture, yet systematic data on contract terms remains scarce. We identify key data gaps and propose a framework for data collection that individual researchers can build on. Download Paper Abstract Contracting is widespread in agriculture, yet there is no systematic data collection on the nature and importance of agricultural contracts. We argue that such data collection is needed to build further knowledge and support more specific research projects. Collecting data from individual contracting parties is difficult, but a summary of responses about specific contract characteristics coupled with sectoral descriptions would provide general information that individual researchers can utilize when launching investigations on more specific topics. ...

What does an optimal agricultural contract look like? We show how to use production data to design incentive-compatible contracts, and apply the method to California's processing tomato industry. Download Paper Abstract This article shows how available production data can be used to construct the terms of an efficient contract. The approach is applied to the design of a contract for processing tomatoes, a commodity for which a variety of different contractual provisions are used in practice. The analysis yields estimates of the efficient level of incentive intensity, the efficient degree of risk sharing, and the welfare cost of using suboptimal contract terms. ...

What does an efficient contract between tomato growers and processors look like? We estimate an agency model and find that existing quality measurement improves efficiency, but information constraints still cost about 1% of mean compensation. Download Paper Abstract An agency model of contracts used in California’s processing-tomato industry is estimated in three stages. We first estimate growers’ stochastic production possibilities, and then, for a given vector of preference parameters, compute an optimal compensation schedule. Finally, we compare computed compensations with actual compensations and choose preference parameters to minimise distance between the two. Assuming perfect competition and risk neutrality for processors, we obtain an estimate of 0.08 for growers’ measure of constant absolute risk aversion, and find that growers who face higher-powered incentives produce higher levels of soluble solids, at a cost that is 1.8 per cent greater than otherwise. Efficiency losses from information constraints are 1 per cent of mean compensation, whereas existing quality measurement improves efficiency by 1.08 per cent. ...

When farmers produce under contract, there is a tension between risk and incentives. We provide a simple characterization of optimal risk and show that "less risk" need not mean "smaller variance." Download Paper Abstract When farmers produce under contract, there may be an important tension between risk and incentives. We provide a simple characterization of the optimal risk in any production system. We also show that “less risk” need not imply “smaller variance,” and that while at the margin the behavior of risk-averse farmers may appear to be nearly risk-neutral, it does not follow that one can generally treat such producers “as if” they were risk-neutral without being greatly led astray. ...

How do processors ensure that growers deliver the quality they promise? We identify four policing instruments—input control, monitoring, quality measurement, and revenue sharing—used in California produce contracts. Download Paper Abstract We examine mechanisms of coordination in agricultural contracts, with an approach intended to advance understanding of social relations of production and distribution of power in agrofood systems. Through analysis of contracts between farmers and intermediaries for California fruits and vegetables, we identify three functions of contracts: they help to coordinate production, they provide incentives to induce particular behaviors, and they allow farmers and intermediaries to share risk. These functions are implemented via four policing instruments: input control, monitoring, quality measurement, and revenue sharing, which are employed by intermediaries to mitigate blind spots in contracts and to control farmers’ actions and the quality of their output. ...

Spot markets for agricultural commodities reveal information about grower quality that contracts can exploit. We show how market prices serve as a form of relative performance evaluation. Download Paper Abstract We develop a model in which an agricultural spot market serves as a relative performance evaluation device. In this setting, the market price conveys information about factors common to all growers, such as weather, which helps to distinguish the quality of an individual grower’s effort from factors beyond the grower’s control. We derive the optimal contract between a processor and a grower and show that the contract offers the grower partial insurance against market price fluctuations while retaining incentives for effort. ...

Contracts between growers and handlers use four instruments—input control, field visits, quality measurement, and residual price risk—to align incentives and coordinate production in California produce markets. Download Paper Abstract We examine the structure of contractual relations between growers and first handlers in California fruit and vegetable markets. We identify four generic instruments—input control, field visits, quality measurement, and residual price risk—which are used to coordinate relations between growers and first handlers and which help to alleviate information asymmetries and align incentives between contracting parties. ...

How does contracting change a farmer's supply response to price changes? When intermediaries absorb risk and farmers have private information, supply response is dampened relative to spot-market farming. Download Paper Abstract We consider four environments in which agricultural producers might operate, studying the role of price and production risk in shaping farmers’ supply-response decisions. In the first two environments, farmers market their own produce and are risk neutral and risk averse, respectively. In the third, farmers are risk averse, but risk neutral intermediation predicts that farmers should not face any production or price risk. In the final environment, risk neutral intermediation continues but the possibility of private information for farmers is admitted, which rationalizes exposure to production and price risk and suggests that a farmer’s response to a change in expected price will be less pronounced than in other environments. ...

Why don't contracts fully insure growers against price risk? Because price conveys information about quality that direct measurement misses, so efficient contracts leave growers exposed to some price risk. Download Paper Abstract Risk-averse farmers in the produce industry grow a product whose market price is often quite unpredictable. Shippers or other intermediaries shield the farmer from much of this price risk; however, actual contracts between growers and shippers vary considerably across commodities in the residual price risk growers face. We hypothesize that imperfect quality measurement results in a moral hazard problem, and that price provides additional information regarding quality. As a consequence, an efficient contract does not shield growers from all idiosyncratic price risk. ...

Are firms credit-constrained, or do they just look that way? We develop methods to distinguish exogenous borrowing limits from endogenous constraints that arise from incentive problems. Download Paper Abstract Are firms and households constrained in the use of a productive input? Theoretical approaches to this question range from exogenously imposed credit allocation rules to endogenous market failures stemming from limited-commitment or moral-hazard problems. We develop and implement econometric methods that allow us to distinguish among these different sources of constraints. We apply these methods to Thai data on rice farmers and find evidence consistent with moral hazard but not with exogenous credit constraints. ...