LAND AND LIVESTOCK CONTRACTING IN AGRICULTURE: A PRINCIPAL-AGENT PERSPECTIVE
Charles R. Knoeber
Professor, North Carolina State University
© Copyright 1997 Charles R. Knoeber
The seemingly disparate literatures on land tenancy and on the contractproduction of livestock actually have much in common. Here, they areexamined together within a simple principal-agent framework. The core of thisframework and a central issue in much writing on these agricultural contractsis the trade-off between smaller risk-bearing costs and better incentives forfarmer effort, for the revelation of information, and for innovation. Therelative importance of risk and incentive in explaining the design and use ofland tenancy and livestock production contracts remains a key topic forresearch.
JEL classification: L14, Q12, Q15
Keywords: Land, Livestock, Contracts, Agriculture
Contractual arrangements in agriculture have attracted research interest alongseveral different lines. One primary focus is land tenancy. The causes andconsequences of sharecropping, land rental, and owner-operator farminginform a long, active, and widely-known stream of research (surveys includeNewberry and Stiglitz, 1979; Binswanger and Rosenzweig, 1984; Otsuka andHayami, 1989; Singh, 1989; and Otsuka, Chuma and Hayami, 1992).
A second important focus is more recent and less widely-known, arisingout of the changing organization of livestock production in the United States(Shelden, 1996 provides an overview). Traditionally, livestock producers havebred and raised animals for sale in auction markets. Beginning with broilerchickens in the 1950s, followed by turkeys, and now spreading to swine anew form of contract production has come to dominate (see Knoeber, 1989and Menard, 1996 for a description of broilers; and Martin, 1994 for swine).Increasingly, "growers" raise animals under contract for large "integrator"firms. Under this new arrangement, an integrator firm provides young animals(chicks, poults, feeder pigs), feed, medicine, and advice to contract growers.Growers provide housing, utilities, labor, and management. Animals are keptby growers until maturity, but are owned by the integrator firm. At maturity,animals are collected by the integrator and transported to slaughter andprocessing plants. For broilers and turkeys, the breeding of chicks (poults),mixing of feed, and slaughtering and processing are all typically done by theintegrator firm. For swine, integrators mix feed but only sometimes breed pigsand only rarely operate packing plants. These contracts share some featureswith contracts that have been used for several decades to organize theproduction of fruits and vegetables for processing (see Reimund, Martin andMoore, 1981 and Knoeber, 1983). Reasons for the advent of contractproduction and the nature of its effects are important emerging researchtopics.
The issues in land tenancy and in contract production are similar.Examining these two related research streams is the purpose of this survey. Asimple principal-agent framework is used to organize the discussion, and theprimary focus is choice of contract form. This approach narrows the range ofissues discussed. An abstract setting in which a single principal contractswith a single agent and in which only the agent's actions are of concernprovides the background for much of the survey. Attention is paid tosituations where a single principal contracts with multiple agents, but thepossibility that the actions of the principal (as well as those of the agent)matter is generally ignored (Reid, 1977, Eswaran and Kotwal, 1985, Allen andLueck, 1993, and Battacharyya and Lafontaine, 1995 all examine this doublemoral hazard case). Collective contracts which unite farmers into cooperativesare also ignored. Finally, the effects that varying institutions (largelygovernmental) have on contract choice receive scant attention. This isappropriate for the discussion of livestock contracting which is largelyrestricted to activity in the United States, but is a defect in the discussion ofland contracting which, while emphasizing the United States experience, isintended to be substantially broader.
All contracts are formed because the parties involved expect to benefit. In theagricultural context, a focus is often the source of these benefits. One strainof literature emphasizes the stochastic nature of prices and productionoutcomes facing farmers and views contracts as a vehicle to shift (or share)risk. In this strain, the important benefit of contract production and marketing,as well as sharecropping or other land tenure arrangements, is the reductionin risk-bearing costs. Another strain emphasizes efficiencies in theorganization of production. Here, the important benefit of contracts is thereduction of transaction and production costs afforded by specialization andthe incentives that contracts provide for effort, revelation of information, andinnovation.
The literature emphasizing the benefits from shifting risk presumesimpediments to trading risks directly, as in insurance markets, which limitrisk-shifting opportunities for participants in agriculture. Agriculturalcontracting offers a second-best technique to reallocate the risks of farmingand processing. In this literature, the effects of contract design on behavior,except those that follow directly from changing the riskiness of producer orbuyer profit functions, are often ignored. But shifting the risk of productionoutcomes to others also reduces the incentive to achieve better outcomes,since (part of) the gain to better outcomes inures to others. Indeed, if all riskis shifted, as when a farmer is simply paid a wage unrelated to his effort, thefarmer is left with no incentive to work hard or to make good, but difficult,decisions. The reason is that the costs of such actions are borne by thefarmer and all gains go to the employer. Where these incentive effects arerecognized, they are treated as a cost which limits the extent to whichagricultural contracts can be used to shift risk.
The literature emphasizing production efficiencies takes the oppositeapproach. Here, agricultural contracts are often analyzed presuming riskneutrality, explicitly ignoring any risk-bearing effects that they may have. Thefocus is how contract design affects the incentives of farmers (andprocessors) and so ultimately the costs of production. Where risk isconsidered, it is treated as a cost of providing better incentives. For example,tying a farmer's income more closely to production outcomes providesincentive to improve these production outcomes but also forces him to bearmore risk. Here, the farmer's aversion to risk limits the extent to whichincentives can be improved.
While these two strains of literature differ in emphasis, they overlap intheir attention to the trade-off between the reduction in the costs of riskbearing and the provision of better incentives. This trade-off is the core of theprincipal-agent problem and provides a useful framework from which to viewthe literature on agricultural contracting.
Consider a farmer (agent) acting for a landlord (principal). The farmer providesan input, effort, that contributes to output. Denote effort as a and output asX, where X(a) and X ' >0. The farmer's income, I, depends upon the contractthat he faces and in general form is written I = X + a + , where and arerewards to greater output and effort respectively. Here, the farmer's incomedepends upon output, his effort, and the parameter, , which is a fixedpayment and can be thought of as a non-contingent wage. If both = 0 and = 0, the farmer's income is unrelated to his behavior and so he has noincentive to provide effort. To induce effort, the contract can provide either > 0, > 0 or both. If = 0 and > 0, the farmer is rewarded on the basis ofhis effort only. This is an incentive wage payment. If > 0 and = 0, thefarmer is rewarded on the basis of his output only. This is a cropshare orpiece rate payment. If = 1, = 0, and < 0, the farmer receives all outputand has a negative fixed payment. This is a land rental contract.
Why might one form of contract be preferred to others? If providingincentive to the farmer is all that matters, any level of effort can be inducedusing a positive , a positive , or a combination of the two. None seems tohave an advantage over others. Differences arise when the costs of using Xor a to reward the farmer are considered. These costs take two forms. One isrisk-bearing cost; the other is monitoring cost.
Monitoring costs arise because it is necessary to measure. If the farmer'sreward is based on output, X must be measured. If the farmer's reward isbased on effort (input), a must be measured. In many circumstances,monitoring costs will be less when reward is based on output for tworeasons. First, the physical nature of output often allows easier measurement.This will be the case where output is less subject to variation in quality andhas fewer dimensions than effort. Second, it will typically be true that outputmust be measured for purposes of sale whether or not it is the basis for farmerreward. If so, and if no additional measurement is necessary to reward thefarmer (additional measurement would be required if, for example, the cropwas not of uniform quality and the farmer's reward was a portion of the cropitself), the relevant monitoring cost is zero when output is used as the basisfor farmer payment. The high cost of measuring effort also makes it likely thatan imperfect measure will be used. So, measuring effort likely will be bothmore costly than measuring output and less precise. The degree ofimprecision depends upon the cost of refining measurement. As aconsequence, we can think (roughly) of the choice of how to reward a farmeras that between a precise measure of output, X and an imprecise estimator ofeffort, â. Since â is an estimator of a, it measures effort with error.Importantly, this introduces risk into the farmer's reward. Using â as the basisfor rewarding a farmer, then, entails two disadvantages relative to using X.Measurement costs are greater and the farmer is forced to bear the risk oferrors in the measure of his effort. For this, a risk averse farmer must becompensated. It seems that rewards based on output will provide incentivemore cheaply than rewards based on effort.
But, so far, the important cost of reward based on output has beenignored. Output, while increasing in effort, has a large random component.Weather, pest infestations, and many other exogenous forces have markedeffects on X. Rewards based on output may be quite risky, and bearing thisrisk is costly. The relative cost of rewards based on output depends upon thesize of these risk-bearing costs (costs of measuring output are presumed tobe zero) compared to the sum of monitoring costs and smaller risk-bearingcosts associated with rewards based upon an estimator of effort, â.
To see how this affects the form of contract used, consider severalextreme cases. First, if the farmer is risk neutral (so, risk-bearing costs arezero) and measuring effort is costly, incentive can be provided most cheaplyby rewards based on X. A land rent contract with = 1, = 0, and < 0seems optimal. Second, if the farmer is risk averse and monitoring costs arezero (effort can be measured without error at no cost), incentive can beprovided most cheaply by rewards based on effort. An incentive wagecontract with = 0 and > 0 seems optimal. Third, if the farmer is risk neutraland monitoring costs are zero, a land rent contract, an incentive wagecontract, and combinations of cropshare and incentive wage contracts (where0 < < 1 and > 0) all work equally well. Finally, the most interesting case isthat where the farmer is risk averse (so risk costs matter) and monitoring costsare positive. Here, there is a trade-off. Effort can be maintained by increasing and decreasing or the reverse. Optimality requires raising until theadditional risk-bearing costs just offset the savings in monitoring costs fromthe corresponding reduction in . Models focusing on this trade-off betweenincentive and risk costs include Stiglitz (1974) and Warr (1978).
Drawing especially on early work by Johnson (1950), Cheung (1968, 1969)characterizes sharecropping as motivated by gains from risk shifting. Johnsonnotes that an exogenously imposed sharecropping contract (0 < < 1 and = 0) provides too little incentive for the farmer to provide effort since hereceives only a fraction () of the gain and incurs all of the cost, but Johnsonalso argues that competition works to eliminate insufficient effort. Landlordand tenant will contract not only over the share of output each receives butalso over the required effort of the tenant. If effort is insufficient, the lease willnot be renewed. Essentially, a is assumed to be easily observable (monitoringcost is zero), so a minimum level of a can be written into the contract.Recently, Banerji and Rashid (1996) have argued that tournaments in which atenant farmer's output is compared to that of other tenants provide onemechanism for the landlord to deduce the farmer's effort. With effortobservable, competition forces the farmer to provide the contractual minimum.Cheung (1968) extends Johnson's argument by explicitly assuming thattransaction costs are zero. With this assumption, any contract (cropshare,lease, wage) provides appropriate incentive for effort. Cheung argues thatsharecropping is used because it provides for risk sharing. Apland, Barnesand Justice (1984) and Petersson and Andersson (1996) adopt this frameworkand, ignoring any incentive effects, attempt to estimate the risk-sharingbenefits from cropshare contracts for sample farms in the United States andSweden respectively.
A difficulty with Cheung's argument, however, is that sharecropping isnot universal. If sharecropping is equivalent to other contracts in incentiveand superior in risk sharing, why are other contracts also used? Cheung's(1969) answer is that transaction (monitoring and contracting) costs are notalways zero. This allows a trade-off between risk sharing and incentive, atrade-off that may be unfavorable to cropshare contracts.
Stiglitz (1974) and Newberry (1977) also treat risk sharing as themotivation for cropshare contracts and develop conditions under which thesecontracts provide efficient incentives. In addition, both authors along withReid (1976) show that where monitoring is costless and risk enters throughstochastic output, sharecropping is unnecessary to shift risk. A mixture ofrental and wage contracts can duplicate the risk shifting effected by acropshare contract. These results and a general unwillingness to accept thatmonitoring costs are zero, has led to substantial criticism of risk sharing asthe primary motivation for sharecropping (see especially Jaynes, 1984). In aninteresting twist, Reid (1973, 1976) argues that risk considerations motivatesharecropping, but through risk reduction not risk sharing. Cropsharecontracts provide superior incentives to adapt to post contractual changes inthe environment and so to dampen the effect of nature on output, reducingrisk itself.
Even more so than cropshare contracts, livestock production contracts areviewed as motivated by risk sharing. Kliebenstein and Lawrence (1995,p.1215) state that "the primary reason (that growers enter swine productioncontracts) is risk reduction". Similarly, Johnson and Foster (1994) ignore anyincentive effects and evaluate the desirability of swine production contractsto growers in terms of the risks that growers must bear. Knoeber andThurman (1995), while not arguing that risk sharing necessarily motivatescontracting in broilers, estimate the extent of risk shifting afforded by contractproduction. This is substantial. Martin (1994) makes similar estimates forswine production. But here, the extent of risk shifting is not as pronounced.
Although livestock production contracts do provide considerable riskshifting and although observers and participants claim that this is the mostimportant motivation for such contracts, no studies have tested for a linkbetween risk and the incidence of such contracts. A number of tests havebeen conducted for cropshare contracts. If risk shifting is important,cropshare contracts should be observed where yields are most uncertain.Higgs (1973) finds weak evidence consistent with this implication for cornand cotton in the early twentieth century in the southern United States. Rao(1971) finds opposing evidence for Indian farms. More recently, Allen andLueck (1992b, 1996), for farms, and Leffler and Rucker (1991), for timberland,find no relation between risk and the nature of contracts chosen.
Focusing on Cheung's (1969) assertion that transactions costs (monitoringand contracting costs) are important in explaining the incidence of contracts,another stream of literature emphasizes incentives to explain sharecropping.Higgs (1974); Alston and Higgs (1982); and Alston, Datta and Nugent (1984),while not denying the potential importance of risk sharing, argue thatdifferences in supervision costs (costs of measuring a) help explain variationin the extent of sharecropping for crops that have similar yield variability.Where it is more costly to measure a, sharecropping, or basing farmer rewardson X, becomes more likely. All three papers find evidence consistent with thisprediction using historical data for the southern United States. Evidence forIndia is presented in Datta, O'Hara and Nugent (1986).
Bell and Zusman (1976) and Stiglitz (1988) also emphasize difficulties inmonitoring farmer effort as a rationale for sharecropping. Where measuringeffort is expensive (so minimum a cannot be fixed by contract), a sharecontract, with " > 0, provides incentive but only by imposing risk on thefarmer. Trading off the loss from too little incentive against that from too greatrisk bearing defines the optimal share contract. If capital as well as labor isallowed as an argument in the production function and if these inputs arecomplementary, introducing a link to credit into a cropshare contract may bedesirable. Providing subsidized credit to a sharecropper will induce greateruse of capital and so greater labor productivity and hence more effort (thismay not be true if tenants also work off the farm; see Subramanian, 1995). So,the common occurrence of interlinked credit and cropshare contracts mayhave its origin in the difficulty of providing incentives for effort (seeBraverman and Stiglitz, 1982, 1986 and Mitra, 1983).
Murrell (1983), Eswaran and Kotwal (1985), and Chew (1991) all ignore riskcosts and focus on contracting costs to explain sharecropping, but thestrongest statement of the primacy of incentives (the irrelevancy of risksharing) is in Allen and Lueck (1992b, 1993, 1995, 1996). Assuming riskneutrality, they construct a framework in which measurement andenforcement costs dictate the form of contract chosen. They use thisframework to explain both the choice between cropshare contracts and othersand the choice of input and output shares when cropshare contracts areused. Using data for farms in Nebraska and South Dakota, they provideevidence that is consistent with the importance of these measurement costsand the unimportance of risk-bearing costs in explaining contract choice.
The literature on livestock contracts never ignores risk but only sometimestreats risk sharing as an end in itself. Shelden (1996) adopts a principal-agentframework to characterize contracts as providing incentive for effort byrewarding growers on the basis of output, X, but at the cost of imposing riskon growers. Knoeber (1989) also treats incentive as primary, but argues thatthe design of broiler production contracts can be explained partly as intendedto provide this incentive while minimizing the risk borne by growers.Reducing the risk cost of providing incentive allows for higher poweredincentives. An interesting feature of broiler production contracts is thatgrowers are rewarded based upon relative performance where performance ismeasured largely by feed conversion, the effectiveness with which feed isused to produce meat (effort, or a, is not measured). A grower's pay rises ashis performance improves, not absolutely but relative to the performance ofother growers. This scheme, which is like a tournament, shifts risks which arecommon to all growers (weather, feed mix, chick genetics) to the integratorcompany (on relative performance payments, see Lazear and Rosen, 1981 andHolmstrom, 1982). Common shocks, like bad weather, reduce all growers'absolute performance but leave each grower's payment unchanged if relativeperformance is unaffected. For example, a contract that rewards a growerbased upon his output relative to the average of other growers, uses Xi - X/n to measure grower i's performance. If bad weather affects each groweridentically, each grower's X will move in lock-step, leaving grower i's relativeperformance unchanged. Where substantial variation in absolute performanceis common to all growers, contracts such as those used in the broiler industrycan provide incentive to growers with less risk-bearing cost than contractsrewarding absolute performance. Knoeber and Thurman (1994) test a numberof hypotheses arising out of the theory of tournaments using broilerproduction data.
In addition to incentive for effort, livestock production contracts may bedesigned to alleviate another incentive problem. This is the hold-up problemdiscussed by Klein, Crawford and Alchian (1978). When production requiresinvesting in an asset that is specialized to a particular trading partner, anydeal made prior to investing in the specialized asset may not be enforceableonce the investment is made. The non-investing party has an incentive to usehis newly created bargaining power (the cost of the specialized asset cannotbe recouped elsewhere) by demanding more favorable terms. Productioncontracts that require both parties to invest in assets specialized to the other(or an exchange of hostages as described by Williamson, 1983), as is the casewhere growers invest in animal houses and integrators invest in breedingfacilities, feed mills, and processing plants, help to alleviate the hold-upproblem. This role for livestock production contracts is emphasized byKnoeber (1989); Frank and Henderson (1992); Barry, Sonka and Lajili (1992);and Sporleader (1992).
Even with no concern for risk or farmer effort, asymmetric information maymotivate the design of contracts. Where farmers differ in ability, it may beimportant to choose farmers to match productive circumstances. For example,for climates and crops where adaptability (decision making) is crucial, moreable farmers are desired. Where rote response is sufficient, less able farmersare suitable. If only farmers know their own ability and if farmers areheterogeneous, the design of contracts may act to induce farmers toself-select into appropriate matches. Hallagan (1978) explains thesimultaneous use of wage, share, and rental contracts as a response to thisselection problem where entrepreneurial ability is important. Where lowentrepreneurial ability is sufficient, landowners will offer (low) wagecontracts. Where high ability is necessary, landowners will offer (high) landrental contracts. Where intermediate ability is appropriate, share contracts willbe offered. Those with the highest entrepreneurial ability will be willing toaccept only the rental contract; those with the least ability will be willing toaccept only the wage contract; and those with intermediate ability will bewilling to accept only the cropshare contract. A similar argument, but viewingability more generally is developed by Newberry and Stiglitz (1979). Brownand Atkinson (1981) provide a test of this selection hypothesis by examiningcropshare contracts in Indiana. They argue that where entrepreneurial abilityis more important, the farmer's share will be greater (this is closer to a rentalcontract), and test by examining the scope of farmer decision making acrosscontracts with varying farmer shares. They find evidence that as the scope ofdecision making increases (ability becomes more important), farmer sharesincrease as well, consistent with the selection hypothesis.
Allen (1982) argues that where it is only farmer ability that isasymmetrically known, wage and cropshare contracts are unnecessary toinduce selection. If farmers have all decision making authority, as is the casewith rental contracts, they will sort themselves correctly. However, Allen(1982, 1985) also offers two reasons why share contracts may occur forselection purposes. First, if landowners wish to maintain somedecision-making authority, as would be the case if in addition to asymmetricknowledge of farmer ability there is also asymmetric knowledge about landquality (landowners alone know the quality of their holdings), sharecroppingmay arise. Second, if contracts must be self-enforcing (courts cannot becounted on), sharecropping may arise. Since both rental and cropsharecontracts necessarily imply a loan of land to the farmer until the crop isharvested, both are subject to farmer default. Default entails absconding withthe entire crop or not paying the agreed upon rent. If landowners can learnfarmer abilities by observing the size of the harvest, an equilibrium may arisewhere farmers of low ability select wage contracts, farmers of high abilityselect share contracts and are later rewarded for performance (notabsconding) with larger plots (and so more income). Share contracts, then,provide a self-enforcing mechanism to induce selection.
There may be a similar role for selection in livestock production contracts.These contracts require growers to build expensive animal houses, with littlesalvage value. Growers of high ability likely will find this investmentprofitable; those with low ability likely will not. Knoeber (1989, p.280) notesthat broiler companies (integrators) claim that an important reason for the useof contract growers is the refusal of high quality growers to work for wages.That is, contract production selects for high quality growers. The likelyreason for the importance of high quality growers is that suggested byHallagan (1978); the rapid technological change which characterizes thebroiler industry requires growers of high entrepreneurial ability.
Is there a link between innovation and contract form? Bhaduri (1973) claimsthat sharecropping retards innovation, but the case is not clear. Since a sharecontract divides the gains from innovation (like the gains from farmer effort)between landlord and tenant, neither seems to have sufficient incentive toinnovate. But if transaction costs do not interfere, Cheung's (1968) argumentfor the efficiency of share contracting applies equally to effort and toinnovation. As long as contracts can be adapted easily, extant sharecontracts should have little influence on the incentive to adopt newtechnologies. Transaction costs aside, then, there should be no relationbetween the form of contracts (cropshare, lease, wage) and innovation. Buttransaction costs may matter. Newberry (1975) argues that innovation mayboth increase output and make it more difficult to provide incentive to tenantfarmers (require more resources devoted to measuring a in order to assurethat effort does not fall below that agreed upon or greater risk-bearing costsfor the tenant if the (now, less precise) original measure of a is still used). Ifthis is the case, innovations that would be undertaken with rental contractsmay sometimes be foregone with share contracts. This transaction costsargument suggests less innovation with sharecropping.
Empirical evidence, at least in developing countries, shows no relationbetween innovation and contract form. Parthasarathy and Prasad (1974) findno effect of share tenancy on the adoption of high yield varieties of rice in anIndian village. Ruttan (1977) summarizes research showing no persistent lagamong sharecroppers in the adoption of new varieties of rice and wheat inAsia during the Green Revolution of the 1960s and 1970s. Similarly, Feder,Just and Zilberman (1985) conclude that no clear relation exists betweentenancy and the adoption of agricultural innovations.
These empirical findings are not surprising. If sharecropping's effect oninnovation were substantial, contracts that better facilitate innovation shouldreplace share contracts. Interestingly, there appears to be a positive relationbetween the pace of technological innovation and contract production inlivestock industries. Improvements in feed conversion in the United Stateshave been most rapid and most persistent for broilers and turkeys wherecontract production dominates, recently rapid for hogs where contractproduction is increasing, and relatively slow for cattle where contractproduction is less significant (Knoeber, 1989). Similarly, adoption of newbreeding technologies seems positively related to (contract) integration inlivestock production (Johnson, 1995). This suggests that contracts mayfacilitate innovation. Knoeber (1989) provides an explanation for broilers.Here, decisions to adopt innovations (new genetics, etc.) are made by theintegrator companies. Also, broiler contracts compensate growers basedupon relative performance. These contracts serve two complementarypurposes. First, they protect growers from the risk associated with innovationexperiments. Innovations may raise or lower absolute performance, but havelittle effect on relative performance. So growers will not resist innovation.Second, these contracts automatically shift all of the gains from innovation(increases in absolute performance) to the integrator company. As a result,those making adoption decisions face the full costs and benefits of thesedecisions without the necessity to rewrite contracts (no additionalcontracting costs are incurred). The form of broiler production contractsseems particularly well adapted to an environment of rapid and persistenttechnological change.
An important issue in the land tenancy literature but not in that on livestockcontracting is the relation between contract form and performance. Theprimary concern is that sharecroppers who receive only a portion of the gainsfrom effort will have too little incentive and perform poorly. Bardhan andSrinivasan (1971) model this effect. To the extent that contracts are imposedexogenously (or perhaps contractual choice is constrained politically), thisconcern may be warranted. If sharecrop contracts are imposed where rental orowner operation is optimal, sharecroppers should perform worse than rentersor owner-operators and the cross-sectional relation between sharecroppingand performance should be negative. But if contracts are chosenendogenously, share contracts (like others) should be chosen where they aremost effective (Lucas, 1979; Rao, 1971; Morooka and Hayami, 1989; Chew,1993; Tunali, 1993; and especially Otsuka, Chuma and Hayami, 1992pp.2005-2008). Here, sharecroppers should perform no better nor worse thanother farmers. As a consequence, there should be no cross-sectional relationbetween sharecropping (or other contract form) and performance (for astatement of this argument applied to the ownership structure of corporationsand firm performance, see Demsetz and Lehn, 1985; for a test, see Agrawaland Knoeber, 1996). Any empirical relation is either spurious or results fromfailing to control for those features of the environment that makesharecropping (or rental, or owner operation) optimal.
Empirical evidence is largely consistent with optimal (unhindered)contract choice. Bell (1977) and Shaban (1987) are exceptional in offeringevidence of poorer performance by sharecroppers in India. Laffont andMatoussi (1995) also find evidence of poorer performance in Tunisia but doso within an explicit framework in which exogenously imposed creditconstraints on farmers induce sharecropping. Most studies find no sucheffect. Rao (1971), Truran and Fox (1979), and Nabi (1986) are more typical infinding no performance difference for sharecroppers. Cropshare contractsappear to exist where they are optimal.
A substantial portion of the literature on sharecropping has focused on itsuse and its effects in developing countries. This is appropriate both becausethese countries are more agrarian than their western counterparts andbecause sharecropping seems more dominant here. But sharecroppingremains important in developed countries. For some crops and some areas,sharecropping is the primary form of contracting. For example, in the UnitedStates during the late 1980s, cropshare contracts were a large percentage ofall lease contracts in the midwest where grain crops dominate (more than 50%in Kansas, Illinois, and Indiana; more than 40% in Iowa and Missouri). Animportant question is whether the function of sharecropping is the same inboth developing and developed economies. The generally lesser use ofcropshare contracts (relative to rental or wage contracts) in developedeconomies offers a clue. What is it about the development of markets thatmight lead to a decline in sharecropping? One possible answer is that withbetter markets also comes less risk or at least better ways to shift risk. Moreextensive agricultural markets reduce the effects that local conditions have onprices and so may reduce the risk associated with farming (depending uponthe correlation of output among local farmers and the correlation betweenlocal output and price). But even if this is not the case, better insurancemarkets provide alternatives to sharecropping as ways to share risk. Moredeveloped markets reduce (or perhaps eliminate) the risk-shifting motivationfor sharecropping. This may account for sharecropping's lesser importance indeveloped countries. But more extensive markets and the anonymity that theyallow also will affect measurement costs and so, in turn, the incentivemotivation for share contracts. These changes in measurement costs, then,also may account for the lesser importance of sharecropping in developedcountries (and for the variation in the importance of sharecropping acrosscrops and regions).
Both arguments are made by Otsuka, Masao and Hayami (1986) to explainthe lesser use of share contracts (relative to rental contracts) for drivers ofjeepney (taxi cabs) in urban as opposed to rural areas of the Philippines. The"thicker" urban market is less risky than rural markets making urban sharecontracts less desirable on risk-sharing grounds. But also tight knitcommunities in rural areas (relative to the anonymity of urban areas) reducethe cost of monitoring drivers. Low effort by drivers is known more readily byowners in rural areas. So, measurement costs are relatively high in urbanareas, again making share contracts less desirable. Similar arguments mayexplain the lesser use of cropshare contracts in more developed countries. Ifso, more active crop insurance markets (or more extensive governmentdisaster payments) should coincide with lesser use of share contracts.Similarly, lesser migration (tighter knit communities) should coincide withgreater use of cropshare contracts.
Little role for risk considerations in contract choice in developed countriesis consistent with the claim of Allen and Lueck (1996) who argue thattransaction costs determine contract use in modern United States farming.Examining more carefully the nature of measurement and enforcement costsseems a fruitful approach to studying agricultural contracts. Allen and Lueck(1992a) do this to explain the length of farmland contracts and whether theirform is oral or written. In related work (Allen and Lueck, 1997), they alsoaddress a very interesting puzzle, the continued dominance of family farms inthe face of growing corporatism in other sectors of the economy. Once again,measurement costs are key. Family farms eliminate the need for measurementof effort since family farmers are residual claimants. But family farms alsorestrict the possibilities for specialization. Where measurement of effort isdifficult and specialization unimportant, family farms should dominate. Wheremeasurement of effort is easier and gains from specialization greater,partnerships and corporations should be important. Allen and Lueck treat(Mother) nature as determining measurement and specialization costs. Whereproduction has a larger random element, the costs of measuring effort aregreater. Where seasonality is less, specialization gains are more important.This implies that family farms will be more likely where nature (weather, pests,etc.) is a more important determinant of output and for more seasonal crops.Allen and Lueck also provide some confirming evidence. That nature andseasonality are more important for agriculture than for other industries isconsistent with the continued dominance of family farms. Further, theimportance of corporate firms in broiler production is ascribed to theelimination of nature's role in much of the production process. Finally, therelative importance of family farms in British Columbia and Louisiana isexplained by the extent of seasonality (more seasonal crops are more likely tobe grown on family farms) and the degree to which nature influences output(weakly, irrigated crops, where rainfall is less important, are less likely to begrown on family farms).
Similarly, despite much opposing commentary, risk costs may not be theprimary motivation for the livestock production contracts increasingly usedin the United States. Focusing on measurement and enforcement costs seemsa fruitful avenue. Interesting puzzles are differences in the extent of contractuse and the design of contracts across varieties of livestock. In the UnitedStates, contract production dominates for broilers and turkeys, is importantfor eggs (although vertically integrated companies are also important andsome auction markets exist), is increasingly important for hogs (but stillaccounts for less than 25% of hog production), and is unimportant for cattle.No attempt has been made to explain this pattern. Additionally, broilercontracts reward growers based on relative performance; turkey contractssometimes do and sometimes do not; and hog contracts almost never do.Contract producers of hogs receive bonuses if they meet absolute (fixed)performance standards. Tsoulouhas and Vukina (1997) suggest a risk-relatedexplanation for this variation in contract form. Concern with bankruptcy riskprecludes the use of relative performance compensation for contractproducers of swine where integrators are predominately closely-held andwhere price volatility is large. In contrast, the predominance of publiclytraded integrators in the broiler industry coupled with lesser price volatilityallows the use of relative performance compensation for contract producersof broilers. But, there also may be a measurement cost explanation of thisphenomenon. Relative performance is a less noisy measure than absoluteperformance whenever common shocks to performance (for example badweather that affects all growers) are large and comparison growers are many.The reason is that relative performance differences-out the noise introducedby common shocks from a grower's performance but also introduces theidiosyncratic variation from other growers' performance (other growers'performance is the benchmark). If the first effect dominates, relativeperformance is a less noisy measure. The noise added by the idiosyncraticvariation in other growers' performance is reduced when there are more ofthese other growers since the individual variations balance out (Holmstrom,1982). The number of other growers and their similarity, then, determinewhether or not relative performance contracts are desirable (Knoeber, 1989and Martin, 1994). Much remains to be done to explain the ongoingrevolution in the contractual organization of livestock production.
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